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What Does the First Half of the Year Tell Us About What’s Coming?

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Written by: Kyle Thompson

“If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.” – George Soros

The above quote is a fitting summation for the first half of the year. In Q1, volatility returned due to trade-war fears and tensions with North Korea. These factors drove down the major broad indices for both equities and fixed income. Our Commentary last quarter focused on the need to remain disciplined and highlighted the disconnect between the downward market performance versus the strong economic data. Investors that remained disciplined in Q1 were rewarded this quarter with reduced volatility and advances in the major US indices.

The Market Street philosophy is to remain disciplined and committed to sound long-term investing principals through all market cycles. This discipline has enabled us to remove the emotional aspect of investing, which in turn has served our clients well over the years. Irrational investors would likely tell you the first half of the year was a volatile ride with many ups and downs. In contrast, we would argue the first half of the year was rather boring with modest market advances. In the words of George Soros, good investing is boring, and clients have continued to see their portfolios grow through the first half of 2018. The table below summarizes index returns for the second quarter, the past 12 months, and annualized returns for the past 3-year period for some of the major asset classes.

Looking Ahead

I am going to make a statement that will probably sound a little odd coming from a financial advisor – “we ignore market predictions and forecasts.” For years I have listened to the so-called experts and market pundits make predictions with resounding confidence. My personal favorite came back in January 2016 when RBS advised investors to “sell everything”. In their January 2016 commentary to investors they went on exclaiming that the current situation was reminiscent of 2008. These outlandish and utterly incorrect predictions do nothing more than create investor fear and anxiety. I am happy to report that none of our clients heeded this advice or missed the ensuing 47% rise in the S&P 500. Instead of making market predictions, which ultimately will be incorrect, we focus our time and energy on actual economic data that enables us to make small strategic adjustments to our portfolios (as detailed in the quarterly report letter that preceded this commentary). Below is a summary of the current state of the economy.

The Good

The data suggests that the economy is still heating up and growing. The year over year (YoY) change in Gross Domestic Product (GDP) growth is at 2.8%, which is above the 2.7% average. There are early indications that Q2 2018 GDP growth could be as high as 5%. The major driver of this growth is the 2018 tax cuts, which are leading to increased consumer spending. Consumer spending accounts for 69% of the US GDP. Based on current forecasts the YoY economic data indicates that GDP growth could be around 3.2%-3.3% this time next year. In addition to accelerating growth, the unemployment rate has fallen to its lowest level since 1969 and wage growth has started to tick up with the shortage of workers in the labor force. The current unemployment rate is at 3.75% and wage growth is at 2.9%

The Not So Good

Inflation is starting to creep up with headline Consumer Price Index (CPI) at 2.7%. While this is another positive indicator the economy is expanding, it will likely put pressure on the Federal Reserve to keep tightening by raising interest rates, as the current CPI is above their 2.2% target. Rates continuing to rise will ultimately stall the economy and growth will start to wane. Rising rates are also having a negative impact on the fixed income markets as rates and bond prices move in opposite directions. Another concern for growth is the lack of workers. The shortage of the working-age population is a real concern and could prevent future growth. The slide below illustrates how the growth rate in the working-age population has continued to decrease. The last decade showed a growth rate of 0.5% while the projected growth over the next 10 years is only 0.2%. The reduction in the working-age population will eventually lead to decreased GDP growth.

So What Does All This Mean….

The two most common questions I get asked are…”What is going to happen next?” and “What should I do?” The answers to both are easy – “I have no idea” and “nothing.” As expected, this response is not always received with exuberance, but clients who have worked with us for a while have come to understand this truth and I would argue have come to appreciate it. I can’t tell you when, but I am certain this economy will slow, and we will go through a period of market underperformance. It is important to understand that market corrections are not a bad thing and in fact are necessary so that we can experience the next bull market cycle.

The average recession lasts around 15 months, while the average expansion lasts 47 months. We are currently in the 109th month of the current expansion, which is the 2nd longest in US history. Since WWII, there have been 11 recessions with the last two being bear markets. A bear market is defined as more than a 20% correction from the market peak within a two-month period. Dr. David Kelly, Chief Global Strategist with JP Morgan thinks this is a positive as our most recent recessionary experiences are atypical. In fact, he would argue that our next downturn is more likely to resemble the previous nine recessions as opposed to the downturns that were experienced with the 2000 tech bubble and 2008 financial crisis.

When the eventual slow down occurs, we will be your voice of reason reminding you to stay the course, remain disciplined, and accept the notion that sound investing is boring. In the meantime, we will enjoy the remaining run of the current market expansion and will work to manage your portfolio in the most cost-effective and tax-efficient manners possible.

If you have any questions, concerns, or otherwise just want to speak about your investments or the economy, please don’t hesitate to contact your Financial Planner or myself at any time. We are always happy to discuss your portfolio with you in light of your own unique personal circumstances.

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