Update on the Markets:
| Index | 3rd Quarter 2018 | Year-to-Date |
| S & P 500 (Large US Stocks) | 7.71% | 10.56% |
| Russell 2000 (Small US Stocks) | 3.58% | 11.51% |
| FTSE All World ex US (International Stocks) | 0.93% | (2.79%) |
| Barclays US Aggregate (Bonds) | 0.02% | (1.60%) |
October 2018
Moving Along Nicely
The third quarter was surprisingly strong for US stocks. Bonds stabilized. The S&P 500 index jumped 7.71% to reach 10.56% with dividends for the year. US corporate earnings skyrocketed again in the second quarter. Year-over-year second-quarter earnings growth should top out close to 25%. On October 5, FactSet reported that the S&P 500 is expected to report earnings growth of 19.2% for the third quarter, but the actual number will probably exceed 20% – the third straight quarter with above 20% earnings growth. Credit is given to a strong economy and massive tax cuts. The effects of the tax cuts won’t last forever, of course, but earnings growth is expected to remain above 10% through 2019.
Things to Worry About
If you’re like me, you’re probably wondering: “How long can this last?” No one knows, of course, but here are some points of concern:
An Overly Aggressive Fed. As expected, on September 26 the Fed raised its benchmark fed funds rate a quarter point to a target range of 2-2.25%. In the Fed notes Chair Jerome Powell was very optimistic about the US economy, so the likelihood for another hike in December is very high. And maybe four more in the next two years. The Fed also removed the word “accommodative” for the first time since the Great Recession. However, as rates rise, there is a risk that the Fed may over-tighten just as the economy and corporate earnings may be topping out, almost guaranteeing a recession.
Trade War with China. The tit-for-tat tariffs between the US and China don’t seem to have an end. Negotiations are not producing any results. We may have to live with this situation for a long time. Tariffs act like taxes on the system. Who pays is the question. Chinese exporters and US corporations may absorb a significant portion of the tariffs, but eventually, the American consumer will still see higher prices. If corporations eat more tariffs, then earnings will decline. If consumers see higher prices, then consumer spending drops. Higher inflation may also lead to a stronger US dollar – crimping US exports and, therefore, corporate earnings. Neither of these outcomes is good for the stock market. In addition, a rise in inflation may cause the Fed to be even more aggressive in raising rates.
Democrats take the House and the Senate. As of this writing, consensus leads us to believe that it is likely that Democrats will win control of the House in the November midterm elections and Republicans will maintain their majority in the Senate, if not even increase it. However, a “Blue Wave” leading to a Democratic takeover of both houses of Congress could spell trouble for the stock market. Tax reform and other business-friendly policies may be rolled back. At the very least, no new “good news” like Tax Cuts 2.0 would be enacted to help the bull market along. On the other hand, an unexpected “Red Wave” could significantly bolster confidence and fire up stocks.
What to Do: The Big Picture
Many things are going well right now. We’re in a “Goldilocks” environment where the economy is strong, but inflation remains subdued. The tight labor market will lead to higher wages and a more confident consumer. The tax cuts continue to boost corporate earnings. The government is also helping by spending more. I already listed a few of my concerns and there are many more. The stock market may drop 5 or 10% or more at any moment – it is not cheap! However, on balance, stocks remain attractive and should outperform bonds. Maintain your neutral asset allocation, looking to add to stocks on dips.
As always, please let me know if you have any questions or comments.
Sincerely,
Henry Gorecki, CFP®
