While you should have recently received our monthly market commentary along with your quarterly billing, recent events prompted us to put together an update on the current volatility in the markets.
The second quarter of 2018 is off to an equally volatile start as it’s Q1 predecessor. On the first trading day of April, US equity markets were down 2%. This marked the nineteenth time that the S&P 500 has moved by more than 1% in a single day in 2018, and 30% of trading days have been marked by such a move. By comparison, 2017 only saw 3% of its trading days experience a move of 1% in either direction. It is no wonder that 2018 has felt like a roller coaster ride! Statistically, 2018 has been 10X more volatile than 2017!
While volatility can be concerning, it is not always a bad thing. Volatility can be a warning sign for potential recession if it is a result of fundamental economic problems. However, volatility can also serve as a healthy reset to the markets if fundamentals remain strong.
When examining these economic fundamentals, it is important to consider the four “Pillars”: 1. Monetary Policy, 2. Taxes, 3. Spending & Regulation, and 4. Trade.1 If these pillars remain structurally sound, there is good reason to maintain a positive outlook.
Monetary Policy – Much attention has been given to the recent Fed Funds rate hike. However, the Fed also upgraded its forecasts for economic growth, projected a lower unemployment rate through 2020, and expects inflation to temporarily exceed its long-term inflation target of 2.0% in 2020.1 Monetary policy will still be loose at the end of 2018, whether the Fed chooses to raise rates three or four times this year. As a result, monetary policy should serve as a driver of growth, not a deterrent.
Taxes – The Tax Cuts and Jobs Act passed last year is the most pro-growth tax cut since the early 1980s, particularly on the corporate side.1 Reducing the corporate tax rate may increase the demand for labor, allowing workers and managers to share the benefits with shareholders.1 Additionally, a lower tax rate gives companies more incentive to pursue new business ideas and expand. Earnings for companies in the S&P 500 are expected to grow 16.8% in 2018, with an increased forecast across all sectors of the market (Figure 2). These estimates continue to be revised upward, as the effects from tax reform and positive economic momentum around the globe filter down to companies’ bottom lines.2 Q1 earnings season will provide an initial look at the impact of these tax cuts on corporate earnings.
Figure 2
Spending & Regulation – While spending has become more of an issue (Federal spending stands at 21 % of GDP), the government has continued to reduce red tape, rather than expand it. It is important to monitor spending, as increased government spending typically slows economic growth. However, the de-regulatory environment created by the Trump administration, particularly in the financial sector, has the potential to create additional expansion.
Trade – While China and the US have recently begun to engage in a retaliatory battle of tariffs, a full-blown “trade war” still does not seem imminent. Over the past handful of days, the US has announced tariffs on Chinese technology products, such as flat-screen televisions, medical devices, and batteries, while threatening to impose further tariffs. China has retaliated by announced tariffs on American soybeans, cars, and chemicals. While these announcements have further escalated tensions, we seem to be stuck in a sort of “tariff tantrum”, rather than a trade war, with both parties responding to one another with heavy-handed tactics, waiting to see who blinks first. Additionally, the tariffs have already proven to be a complex issue. One of the largest tariffs proposed by China is on pork, but the largest U.S. exporter of pork is owned by a company in Hong Kong.3 With this situation constantly evolving, we are watching closely. As a precautionary measure, we have reduced our exposure to the materials and industrials sectors (ex. CAT and XLI).
While there is some “wobble” to these four economic pillars, we still feel that they are predominantly strong, especially the lower taxes, reduced regulation, and current monetary policy. Spending and tariffs are legitimate threats to growth, but existing fundamentals do not currently appear to signal forthcoming economic problems.
As a reminder, in times like these, it is often human nature to want to “time the market”. Recent events have caused some significant short-term volatility in the markets, but current market fundamentals do not compel us to move out of equities. It only takes a handful of days “out of the market” to miss out on a large percentage of potential growth (Figure 3).
Figure 3
As always, we will continue to monitor ongoing developments, while also pursuing buying opportunities presented by the current volatility in the market.
Please feel free to contact us with any questions or concerns.
1. https://www.ftportfolios.com/Commentary/EconomicResearch/2018/3/26/when-volatility-is-just-volatility
2. https://www.lordabbett.com/en/perspectives/equityperspectives/market-volatility-four-important-perspectives.html
3. https://www.wsj.com/articles/china-retaliates-with-new-tariffs-on-u-s-meat-and-other-products-1522618533
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Investment advice offered through Strauss Financial Group, Inc., a Registered Investment Advisor.
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