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2nd Quarter News

Last quarter the markets were stressed as investors absorbed the global uncertainties regarding trade tensions with our commerce partners.  The mix of positive and worrisome news was confusing – and the tea leaves were murky.  Our perspective is clearer as second quarter earnings start to roll out.  The end of the long-running bull market is inevitable. However, we expect the market to still show modest gains for the rest of 2018 and most of 2019.Last quarter the markets were stressed as investors absorbed the global uncertainties regarding trade tensions with our commerce partners.  The mix of positive and worrisome news was confusing – and the tea leaves were murky.  Our perspective is clearer as second quarter earnings start to roll out.  The end of the long-running bull market is inevitable. However, we expect the market to still show modest gains for the rest of 2018 and most of 2019.

We are in agreement with a recent Barron’s article: “Why the Bull Market Could End in 2020.”  The basic argument is pretty straightforward. First, the current strength of the economy and corporate earnings is being boosted by the tax cut stimulus. But that stimulus was front-loaded and will lose impact by mid-2019. Second, the Federal Reserve has clear intent to raise the short-term interest rate from its current 1.75% to 3.5% by the end of 2019. At the same time, the Fed is shrinking its $4 trillion balance sheet. 

The result will be significant slowdown in 2020. The Barron’s analysts are not predicting recession. However, the loss of economic momentum could be enough to put the brakes on the long-running bull market – and throw stocks into a period of bearish setback. 

The good news is that we expect modest market expansion for the remainder of 2018 and most of 2019.   GDP and earnings growth will be healthy for much of that period.   But rich stock prices will keep the market in a narrow trading range.   We are managing asset allocation and stock selections for clients accordingly. It is a defensive strategy for the upcoming period of modest growth and eventual downturn.

The U.S. economic performance is strong. The economy had a net gain of 213,000 jobs in June. Manufacturing, construction, and consumer activity are all vibrant. The forecast is that the GDP will have grown 4% in the second quarter and 3% for full-year 2018. As result, corporate profits are expected to increase 21% in 2018 – compared to 11% in 2017. As explained, the tax cut is working to stimulate this growth – especially with its encouragement of business investments. 

All this positive news means that long-dormant inflation is heating up. The annualized rate of inflation is now over 2% for the first time in nearly six years.  That 2% level is the benchmark that provokes the concern from the Federal Reserve that the economy needs tighter monetary policy. It explains their announced intent to raise interest rates in 25 basis point increments until reaching the 3.5% level by the end of 2019. 

As stated, the economy is not expected to sustain this pace in 2019 and 2020. As the tax stimulus fades, and interest rates increase, the GDP is forecast to grow at about 2.5% in 2019 and slip back below 2% in 2020. Corporate earnings in 2020 should be back at about 10%.  Also, once the tax stimulus fades, the economy will be left with the burden of an increased and massive federal deficit. 


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