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Q2 2018 Market Recap: Trade War Talk Casts a Shadow on Strong Earnings Growth

For Q2, US stocks were up 3.9% (VTI) and international stocks were down 3.5% (VEU). US bonds were roughly flat as the Fed marched forward with its plan to slowly raise interest rates and normalize its balance sheet.

Small-cap stocks outperformed, perhaps because they are viewed as less vulnerable to tariffs. Energy was the best performing sector, up 13.4% (XLE). We view rotating size and style leadership as healthier for a sustained bull market.

Trade war talk rattled global markets and cast a shadow on exceptional earnings growth and a strong overall economy.

As expected, the Fed raised its short-term target rate by 0.25% to a 1.75%–2.00% range. It also suggested that two more hikes, instead of one, are likely in the cards this year. Ultimately, 0.25% one way or the other won’t make or break the economy or the stock market, but a new era in monetary policy puts more pressure on companies to impress.

In 2017, international stocks broke the trend and outperformed the US. As a result, many investors shifted allocations late last year or early this year to more heavily weight international.

The US housing market appears to be in a good place to continue to support the slow and steady economic growth fueling this bull market. In most of the country, owning a home still probably makes sense if you want to stay put for at least 6 years, but valuations are getting extreme in some pockets.

Looking Ahead

In recent weeks, markets have been yo-yoing on talk of a trade war and tariffs. On days when there is little or no trade news, the US market still seems to want to climb higher. We’ve been surprised that the exchange of tariffs has gone as far as it has. The situation has moved beyond threats and is now taxing the global economy.

Steel and aluminum tariffs went into effect in March, and as of July 6 the US has imposed tariffs of up to 25% on $34 billion of Chinese goods. China is implementing retaliatory tariffs expected to be of equal scale. For perspective, 25% of $34 billion is under $9 billion, which is about 1% of the value of Apple.

The Tax Foundation estimates that if all threatened tariffs announced so far are enacted, the impact to US GDP would be around 0.4%. That would be meaningful, but not enough to solely dictate the direction of stocks or bonds. The bigger threat is that as new tariffs are introduced, companies could freeze decision-making and investment until they understand the new rules.

Amid the focus on trade, decisions by the Fed and other major central banks may actually prove more important to the longevity of this bull market. Fed Chairman Powell is data-driven and balanced in considering tradeoffs in risks to inflation and growth. And, as expected, the federal funds target rate was raised a quarter of a point to a 1.75%–2.00% range in early June.

The surprise came from comments suggesting that two more hikes (instead of one) are likely in the cards for this year. Ultimately, 0.25% one way or the other doesn’t make or break the economy or the stock market. But a new, less accommodative era in monetary policy is here. Higher rates will put even more pressure on companies to hit earnings targets in the face of higher borrowing costs.

Don’t Give Up on International

This nine-year bull market has featured gains of over 300% for US stocks and “only” about 130% for international stocks. 2017 was an exception. International led, and emerging markets provided the strongest returns. As a result, many investors shifted allocations late last year or early this year more heavily toward international. This is classic “chasing heat,” and so far it has been a mistake. Predictably, many are now giving up on that bet and moving back toward the US.

The Current Housing Market

The housing market was a major driver of the expansion during the 2003–2007 bull market, and a major casualty when the music stopped in 2008. Once again, home prices are hitting all-time highs, but with very different dynamics from the last cycle. As an important contributor to GDP and a big part of net worth for the 65% of American households that own their home, it is worth keeping an eye on signals from the housing market.

Looking at the big picture, the US housing market overall appears to be well positioned to continue to support the slow and steady economic growth that has fueled this bull market. In most of the country, owning your primary residence still probably makes sense if financially possible, and if you want to stay put for at least 6 years.

To learn more about this quarter, read our free Q2 Market Review and Commentary report.

Read the Report

Disclaimer: This communication and all data are for informational purposes only and do not constitute a recommendation to buy or sell securities. Third party data is obtained from sources believed to be reliable. However, PCAC cannot guarantee that data’s currency, accuracy, timeliness, completeness or fitness for any particular purpose. Certain sections of this commentary may contain forward-looking statements that are based on our reasonable expectations, estimate, projections and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not a guarantee of future return, nor is it necessarily indicative of future performance. Keep in mind investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Craig Birk leads the Personal Capital Advisors Investment Committee and serves as Chief Investment Officer. His focus is translating improvements in technology into better financial lives. Craig has been widely quoted in the Wall Street Journal, Bloomberg, CNN Money, the Washington Post and elsewhere. Prior to Personal Capital Advisors, he was a leader within the portfolio management team at Fisher Investments, helping assets under management grow from $1.5 billion to over $40 billion. Craig graduated from the University of California at San Diego and has earned the Certified Financial Planner® designation.
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