Quarterly Update

The second quarter (Q2) of 2018 seemed to be all about tariffs. There was other market news of course, but headlines regarding the growing trade spat between the U.S. and China were what moved markets most. Even with the disconcerting headlines and market volatility, the U.S. stock market faired decently during the quarter, while foreign markets suffered the bond market held steady.

The Technology and Consumer Discretionary sectors performed well during the quarter, but the Energy sector followed crude prices higher, gaining about 14%. The worst performing sectors were Industrials and Financials, each down about 3%, mostly due to tariff concerns.

Following the S&P 500's technical market correction during the first quarter, investors were anxious about stocks as we entered Q2. The S&P made up some ground during March before tailing off again at quarter's end due to more tariff headlines. As strange as it may sound, market volatility trended lower during most of Q2, but several days of larger declines held down performance.

Here's a summary of how major market indexes ended the quarter

• S&P 500: up 4.3%, up 3.3% YTD
• Down Jones: up 1.8%, about flat YTD
• Russell 2000 (small company stocks): up 8.3%, up 8.2% YTD
• MSCI EAFE (foreign stocks): down 1.6%, down 2.5% YTD
• MSCI EM (emerging markets): down 9.7%, down 7.5% YTD
• U.S. Aggregate Bond Market: about flat for the quarter, down 1.7% YTD

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During the first quarter The Trump Administration announced tariffs on imported goods from around the world, but primarily from China. Predictably, the Chinese government countered with their own tariffs and the two governments were off to the races. More back-and-forth ensued during Q2 with each new headline causing ripples in the stock market. Even a first-ever summit with the North Korean leader couldn't hold the market's attention for long amidst all the trade rhetoric.

Foreign markets took the tariff news hardest, with countries like Germany getting caught in the scuffle. But it was Chinese stocks that fell most in response, with an index of large company stocks down about 15% during Q2. Where this growing trade dispute goes is anybody's guess, but it's likely to continue stoking market volatility in the near-term.

With growth still picking up in the U.S., concerns about Europe and developed and emerging Asia lead to year-to-date declines for the major foreign indexes. Central bankers throughout these areas are still trying to stimulate their economies with negative interest rates, so growth could pick up over coming quarters.

In response to these concerns, as well as short-term interest rates being raised again by the Fed during Q2, the dollar rose in value, up about 6% since mid-April versus a basket of foreign currencies. This reverses a downtrend that lasted for much of 2017 and helps smaller companies since most of their business is domestic and transacted in dollars. If this trend continues, small company stocks could continue to outperform their larger brethren, which would be welcome after a period of underperformance during 2017.

The bond market continued its lackluster performance during Q2. Falling prices caused the ten-year Treasury yield, an important indicator, to rise above 3% briefly during the quarter before falling back. The Fed is expected to raise its short-term benchmark rate two more times this year and perhaps three more times in 2019 as the economy continues to improve. This isn't etched in stone but is causing angst in the bond market as investors reprice interest rate risk.

This repricing is causing the yield curve to flatten, which can lead to an inversion. An inversion happens when shorter-term bond yields are higher than longer-term and is a strong indicator of a coming recession. The yield curve could take years to invert and doesn't even have to. For now, it's an important indicator to watch as the overall U.S. economy is strong and most of the major indicators (including the yield curve) are not signaling an imminent recession.

Diversification is always important but uncertainties in the current market environment make it even more so. There were some rebalancing opportunities during Q2 and there will likely be more during the second half of the year. Should you have any questions about your portfolio, please don't hesitate to ask.

Have questions? Ask me. I can help.

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