As we pass through the final quarter of 2018, the U.S. equity market has seen markedly more volatility than in the prior year. A combination of rising interest rates, tariff threats and general European instability have led investors to take a more defensive posture in the latter half of 2018. This repositioning led to a near 10% drawdown from our September highs in the equity markets, and the 10-year treasury yield has risen nearly 30% in 2018. International markets have fared poorly this year, after a strong showing in 2017. Emerging markets, too, have come under pressure from rising interest rates, pushing a broad index of developing economies down 25% this year. Even taking into account the challenges of the global economy in 2018, U.S. corporate profits remain strong, and there are quite a few bright spots in the U.S. economic data. GDP growth has ticked up in 2018, and real wages are on the rise for the majority of the workforce—two indicators that have been stubbornly static for most of the recovery. November and December are historically strong months for the U.S. markets, and we believe that our current volatility will resolve itself into higher prices in the intermediate term.
As we reflect on this holiday season, we wish you and yours a very wonderful Thanksgiving, as well as, a Merry Christmas, and the very best of good health and prosperity for the New Year.
The markets have started another pullback during the month of October with the primary drivers being fear over rising interest rates and global trade wars. In times of heightened volatility, we tend to step back from the markets and ask ourselves, “Is the correction being driven by economic reality or fear?” - In this case, the pullback is not fully in-line with what we see in the global economies.
Global Economic Outlook: There are more question marks surrounding the outlook for the global economy, as the higher frequency indicators we follow point to a bit of a moderation in growth. Adverse news headlines and market volatility have clearly impacted economic sentiment, and the real issues of trade wars, tighter global monetary policy, and emerging market stress are of concern. That said, the tailwinds of strong consumer sentiment, rising property prices, decent global trade growth, and only mildly tighter global monetary policy settings mean we are probably not facing a recession in the foreseeable future. Still, as the global monetary policy tides turn, and weak spots show up, it’s fair to say that global growth probably has more potential for downside risk than upside surprises. For now, our base case is that growth continues and inflation risks are skewed to the upside.
Risk backdrop: Geopolitical risks remain in the front of everyone’s mind, particularly as domestic politics and economic issues put strain on many of our international relations. Yet, more traditional market risks are taking over in terms of probability and immediacy e.g. elevated valuations for a number of asset classes versus the removal of extraordinary monetary policy stimulus.
In the end, it’s been an odd year and the polar-opposite of last year. In last year’s market, we saw almost no volatility. This year, we have a bond market that is down 4% and a stock market that cannot get out of its own way. The prospects for growth still outweigh the potential risks, so we will stay the course with our positioning. But, we’re keeping a raised eyebrow to rotations in the global economy and future signs of slowing.