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2nd Quarter Markets Summary

BLOG, MARKETS & ECONOMICS  |  3 Jul 2018

By Jon Aldrich

Market Volatility

Market volatility calmed down a bit in the 2nd quarter after a tumultuous 1st quarter that saw an end to the unprecedented calm of 2017. 2018 has been a return to normalcy for stocks after one of the calmest stretches for equities in history that was 2017. The economic cycle and the bull market are getting “long in the tooth” which doesn’t mean that markets are going to crash, but gains will likely be harder to come by not only for the remainder of 2018, but also for the next few years.

The rich valuation of the stock market, still historically low bond yields and a 9-year-old bull market for stocks are plenty of reasons for investors to find gains harder to come by going forward. Throw in other concerns such as tariffs and the rising threat of a trade war as well as the possibility of the yield curve inverting (which has occurred before the last several recessions and can be a sign of an economic slowdown) and you have plenty of issues to be concerned with. Just remember, though, markets like to climb a “wall of worry” so a positive sign, believe it or not, is that there are so many concerns out there. Sort of like when your wife says she is not upset, but you really know she is. It can be a little confusing.

STOCKS, REAL ESTATE & COMMODITIES

The first quarter of 2018 started out very well for stocks around the world, but a mild correction ensued in February and March. However, the second quarter ended up being better for most areas of the stock market, but not all of them.

The S & P 500 which is a broad measure of large stocks in the U.S. had a good second quarter and was up 3.6%. The Dow Jones which is an archaic index of 30 stocks and is only included here because the media continues to refer to it was up 1.1% for the quarter but is still down just under 1% for the year.  Personally, I am not a fan of the Dow Jones average as it is too narrow a representation of the US stock market and prefer the S & P 500 when assessing large company stocks.

What has also been interesting is that Growth stocks (think Apple, Amazon and Google) have left Value stocks (think Verizon, Berkshire Hathaway & General Electric) in the dust the last few years. That is also happening in 2018. However, this difference in how growth versus value has performed has gotten to a historically large gap and could start to revert and value may soon start to do better than growth. Over the long-term Value tends to do a little better than growth, but that has not been the case lately.

LARGE GROWTH STOCKS (orange) vs. LARGE VALUE (blue) YTD

Large Growth vs Large Value

Small US companies, as measured by the Russell 2000 Index were a big winner for the quarter, jumping 7.9%. This may be due to the strength in the US dollar that occurred in the quarter for which smaller companies that do not export as much outside the US would not be affected as much as larger companies that do export a lot of goods. A stronger US dollar makes our goods more expensive to overseas consumers.

International and emerging markets stocks took it on the chin in the 2nd quarter after a great 2017 and strong January in 2018. Again, the US dollar took its toll here as a stronger dollar reduces the returns of overseas investments for US investors. Also, there have been some political concerns in Europe and worries about slowing growth and rising interest rates have also stirred some consternation overseas. Foreign stocks still seem much cheaper than US stocks though when you look at their valuations.

Another winner in the 2nd quarter was US REITS (Real Estate). After rising rates hit REIT stocks hard in the first quarter they have come back strong in the spring quarter, rising 7.3% to get back to even for the year. Real Estate stocks often don’t do so well when interest rates rise because their yields may start to look less attractive to investors than other investments such as bonds. Thus, REIT’s may get sold to buy other investments. However, research has shown that REITS aren’t always negatively affected by rising rates, and the 2nd quarter seems to be proof of that.

So far in 2018, commodities have been doing well, after many years of not so stellar returns. Higher inflation has something to do with that as well as the long-term cycle of the commodity markets.

INDEX ETF

Ticker*

2nd Qtr

Return%

YTD

Return %

S & P 500 SPY 3.6% 2.5%
Dow Jones Industrial Avg. DIA 1.1% -.9%
Russell 2000 (Small US Stocks) IWM 7.9% 7.7%
Russell Mid Cap Index IWR 2.8% 2.3%
Developed International EFA -1.9% -2.8%
Emerging Markets VWO -9.6% -7.3%
US Real Estate VNQ 7.3% 0.0%
International Real Estate VNQI -3.4% 0.0%
Commodities GSG 7.6% 10.1%
  • ETF ticker is the Exchange Traded Fund symbol used that tracks the appropriate index. All data from Y-Charts.com

BONDS

So far 2018 has been a dud for bonds due to rising interest rates and as expected have affected many areas of the bond market. When interest rates rise, longer term bonds are hit the hardest and shorter-term bonds fare the best. It is just the opposite when rates fall. The yield on the 10-year treasury started the year around 2.4% and rose up above 3% for a few days before falling back to around 2.86% at June 30. For the 2nd quarter, though yields held relatively steady and bonds have started to recover a bit.

Ultra-Short bonds have been able to take advantage of rising short-term interest rates to return almost 1% for the year and International bonds (except for emerging markets), have actually risen for the year as well. Emerging Markets bonds have been affected by the stronger US Dollar and rising interest rates. Since many emerging markets countries debt is denominated in US dollars, rising US interest rates make it more expensive for them to service their debt.

Floating Rate Bonds are shorter term bonds of companies with lower credit ratings that reset every 90 days or so. Thus, if interest rates rise the interest rates on these bonds resets to a higher rate. These types of bonds do fine in a rising rate period, but since they do invest in lower quality companies, you have to be a bit careful in this area of the bond market.

AREA OF BOND MARKET ETF

Ticker*

2nd Qtr

Return%

YTD

Return %

Total Bond Market BND -.2% -1.6%
Long Term Bonds (20 Year) TLT .5% -3.0%
Short Term Bonds (1-3 Year) BSV .2% -.2%
Ultra-Short Bonds (90 days) MINT .5% .8%
High Yield (Junk) HYG .6% -.4%
Intermediate Term Tax Free (Muni) MUB .7% -.6%
International Aggregate IAGG .2% 1.5%
Emerging Market Bonds EMB -4.3% -6.5%
Floating Rate Bonds FLOT .7% 1.2%

INFLATION

The US inflation rate rose from 2.4% to 2.8% for the quarter as we are starting to see some signs of inflation and that is why the Federal Reserve has been raising short term interest rates in an effort to cool down the economy a bit and hopefully put the brakes on inflation. In the big picture, though inflation is still well in line with the last several years and does not appear to be a problem for now.

Inflation

Well, that about covers the 2nd quarter for the markets. There has been a lot of gyrations so far in 2018, but not a lot of progress. There is a good chance this environment will continue through the rest of the year.  But as you can see with the differences in the results of the various asset classes, diversification will continue to be important.