Quarterly commentary: October 2018

U.S. economic growth and stock market performance for the third quarter of 2018 was more or less a continuation of the previous quarter. Strong corporate earnings helped U.S. stocks move higher, despite trade tensions and rising interest rates, and U.S. GDP grew at a 4.1% annual pace, the highest since 2014.

We also experienced another period of very low volatility in U.S. large company stocks, as the S&P did not have a single session in the quarter where it closed with more than a 1% move up or down. The news was not as positive abroad. The potential of a trade war between the U.S. and China weighed more heavily and political uncertainty, including UK’s delicate Brexit negotiations and Italy’s significant debt issues, caused continued market volatility in both the developed and emerging markets.

For the 2nd quarter, U.S. small companies were the market leaders, but in the 3rd quarter, the S&P resumed the top spot rising 7.71% to small cap’s (Russell 2000) 3.58%. International stocks were mixed with developed countries (MSCI EAFE) up 1.35%, while emerging markets (MSCI EM) were down 1.09%. Recent interest rate trends muted real estate and fixed income returns for the quarter with REITS up .72% and fixed income (BarCap Aggregate) basically flat at +.02%.

A Mixed Bag on Trade

Trade tensions have eased between our North American trading partners with the pending trade agreement among the United States, Mexico and Canada. There has also been progress between the U.S. and Europe after a July meeting between European Commission President Jean-Claude Juncker and President Trump. The two leaders announced they would start negotiations immediately on a number of areas that include working toward “zero tariffs” on industrial goods and further cooperation on energy issues. They also committed to no new tariffs while these negotiations are being held.

Unfortunately, resolution of our higher stakes battle with China seems nowhere in sight. On September 17th, President Trump announced 10% tariffs on $200 billion worth of Chinese imports, and those duties will rise to 25% at the end of the year. The Chinese Ministry of Commerce retaliated in kind announcing tariffs of 5-10% on $60 billion worth of US goods exported to China. Now that the North American trade deal is sealed and there has been progress with Europe, the administration can focus on resolving our trade dispute with China, which we suspect will happen without a major trade crisis.

The Fed Seeks Equilibrium

The U.S. Federal Reserve has a dual mandate: full employment and stable prices. During and right after the Great Recession, the Fed pulled out all the stops to get and keep the economy going. Once it stabilized, they took a neutral stance. Now that we are close to full employment and inflation remains tame, the Fed has gone from taking their foot off the monetary gas pedal to gently pumping the brakes.

The Fed’s most recent rate hike on September 26th lifted the benchmark overnight lending rate by a quarter point to a range of 2.00 – 2.25%. The Fed projected three more years of U.S. economic growth. The Fed also removed the word “accommodative” from its policy statement, signaling the end of loose monetary policies that had been in place since 2008. The Central Bank still foresees another rate hike in December, and three more in 2019. We welcome this gentle rise in rates, and, as long as they do not move too far too fast, the economy and the markets should be able to digest it without major dislocations.

Why We Stay the Course

“The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.”  – Seth Klarman, value investor and chief executive of The Baupost Group, L.L.C.

2018 is proving to be a year of market fits and starts, and typical divergence between asset classes. The U.S. began the year with momentum from the continued recovery and the Trump tax cuts, causing markets to rally in the first part of the year. But, by the quarter’s end, sentiment had shifted and the S&P tumbled by 10%. Markets proved resilient as the year progressed, bolstered by solid economic metrics and rising corporate profits. By mid-August, the S&P had returned to its first quarter peak.

The 3rd quarter quiet period gave rise to a return to volatility with another abrupt decline in the major indices in September and October, two notorious months for turmoil. This year has also seen a reversal of leadership between domestic and international, as well as large and small cap stocks, and a continuation of the spread between growth and value stocks.

Some investors wonder whether this latest round of volatility signals the end of the bull market in stocks, made worse by the daily drip of sensational media headlines calling for them to move out of harm’s way. Others experience “investment envy” where they lament not being where the action is, tempting them to chase returns at just the wrong time. To both, we simply say “wei wu-wei”, a lesson from our last commentary.

As a refresher, in Taoism, students are taught to let go of things they cannot control. To use an analogy, when you plant a tree, you choose a sunny spot with good soil and water. Apart from regular pruning, you let the tree grow. We made the case that this approach applies to prudent investing as well.

At Wealth Dimensions, our goal is to help you build dependable wealth. Through a lifetime of disciplined pursuit and our collective experience and perspective, we have learned to resist futile attempts at predicting the future, being allured by investment fads or fooled by random chance being peddled as skill. Instead, our methodology focuses on avoiding short-term thinking while keeping our eye on strategies that work over the long run. In our last commentary we discussed a few of these “investment tilts” of value and small company as well as the merits of rebalancing, tools we use to add return or dampen volatility.

Another aspect of our strategy is recognizing that, while U.S. equities are a critical anchor of our portfolios, there are enormous opportunities that exist abroad. The chart below, provided by Dimensional Fund Advisors L.P., breaks down the world in terms of market capitalization: the value of all the businesses around the globe. There is no doubt that China is emerging as a potential rival to the U.S., but this chart shows that on this metric, they have a very long way to go as do many others on the global stage. That said, the U.S. only accounts for half of the world’s market value. So, in our opinion, designing a portfolio that does not acknowledge global opportunity misses an important piece of the investment puzzle.

Source: Dimensional Fund Advisors L.P.

As important as international investing is to a successful portfolio, global business cycles, political dynamics, currency, and a whole host of other factors cause returns to randomly move from country to country over time. Limiting country preferences or trying to determine which countries will outperform in a given time period is a fool’s errand.  For example, over the last 20 years, the U.S. has only led the world in market returns one time! Investors may also be surprised to know that Finland has the best track record with four years on top. By keeping diversified and opportunistically rebalancing, investors can dependably capture global equity returns while reducing concentration and market timing risks.

Going forward, investors can expect both expansions and contractions on our global economy. Attempts to predict these cycles or time markets have proven futile, time and time again. Despite this recent round of volatility, we remain committed to our investment philosophy of prudent global asset class diversification, tempered by an individual’s tolerance or capacity for risk. We do not have any reason to believe the U.S. economy will not continue its pursuit of balanced economic growth, but we also remain prepared for the next downturn, whenever it may present itself.

Thank you for your continued confidence in our services.


For informational purposes only. Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of writing and are subject to change without notice. For more information about Wealth Dimensions, including our Form ADV Part 2A Brochure, please visit https://adviserinfo.sec.gov or contact us at 513-554-6000.

Please be advised that this material is not intended as legal or tax advice. Accordingly, any tax information provided in this material is not intended and cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.