The markets have started to come out of this six-month corrective phase and, as of this writing, we are only a few percentage points away from new highs. In our view, 2018 is unfolding much like a performer walking a tightrope. Risk is heightened, but manageable, and best addressed by agility and focus. That said, there are themes that continue to dominate this economy and we are keeping a raised eyebrow to each of them.
Growth - Global growth should remain solid as the synchronized expansion continues, but the pace is likely to moderate amid tightening monetary policy and financial conditions. Overall, the average growth rate of earnings for companies in the S&P 500 was 21% over the same quarter last year.
Inflation - A likely source of volatility, inflation remains highly regional, with US readings gradually firming, Europe subdued, and emerging markets mixed, but Chinese inflation likely to rise.
Politics - US fiscal expansion may lower recession risk in the near-term, but emerging tariff rhetoric and the potential for targeted retaliation introduce new systemic risk. The biggest question is whether all the global tariff talk is just bantering for position or the catalyst for an actual trade war.
Monetary Policy - In 2018, we expect four rate hikes by the FED, two by the Bank of England, the end of quantitative easing by the European Central Bank, and the Bank of Japan still to be on hold. So, the global trend for rates is higher.
The markets are continuing to trade in a volatile range, with no real direction in place. Performance-wise, the markets have been plus or minus a few percentage points the entire year. But, it “feels” more negative because of the volatility we have experienced since January. There are a few things that stand out to us in this time frame:
1. The economy continues to hold up very well. In fact, the Index of Leading Economic Indicators just came out in June and the index is continuing to hit new highs. Markets/economies rarely turn over when the leading side of the economy is still accelerating.
2. The talk of a global trade war continues. We believe most of the volatility we have experienced in the last five months can be directly attributed to the talk of retaliation between countries. That said, we think the chances of a full-blown trade war are very low.
3. Interest rates continue to rise. Our current unemployment rate stands at 3.8% and we are beginning to see wage pressures. These are the two main drivers to the FED and this leads us to believe that rates will continue to press higher for the foreseeable future.
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