Financial Outlooks: July 2018
July 16, 2018

Financial Outlooks: July 2018



Outlooks: July 2018
 
 




 



Monthly Financial Outlooks are provided by HomeStar Trust Services. HomeStar Trust Services’ experienced team of trust advisors can provide you with the knowledge, tools and personal service needed to assist you in meeting your financial and estate planning goals.  
 

ECONOMIC OUTLOOK

Summary
 
 

Earlier this year we mused that maybe 2018 would be the year for Main Street and not Wall Street. Well, the economy may post a high 3% or low 4% reading for Q2 2018, while the blue chip Dow Jones Industrial Average is down slightly year-to-date. Here are a few comments from the last Fed meeting; “economic activity has been rising at a solid rate”, “business fixed investment has continued to grow strongly” and “household spending has picked up and the unemployment rate has declined”. Pretty good for Main Street, but the Fed’s projected rate path over the next few years contains another five or six quarter point rate increases.

So, the Fed risks “taking the punch bowl away” before the average person gets to have a drink. Markets and the economy will need to ponder future Fed tightening with a higher degree of scrutiny than the prior seven rate increases. One of the main reasons for this is the shape of the yield curve as reflected by the difference between the 10-Year Treasury yield and the 2-Year Treasury yield, currently about .30%. One of our outside strategists, Tom Tzitouris at Strategas, notes “credit risk free curves should not invert, when they do, it’s a sign of a policy mistake”. With the Treasury yield curve the flattest in ten years and central bankers considering five or six more hikes, there is a real risk of short term rates exceeding long term yields, raising the risk of recession.
 
The fact that long term Treasury rates are pretty steady, at around 3.0% despite the Fed hiking short term rates meaningfully, is a sign that investors do not see sustained inflationary pressures over the intermediate term. Tariffs and trade disruptions are increasing prices, wages are moving higher and transportation costs have risen, but the “Market’s” collective wisdom is that these are temporary cyclical pressures that will ease in quarters not years. The dollar is rising as U.S. rates are some of the highest in the developed world, while some major emerging market currency, stock and bond markets are being peppered. We believe that the Fed will heed the message of the market and scale back the timing and amount of future rate hikes. But, we must be vigilant about these outcomes, as our central bank has erred before.
 

Positives

  • U.S household net worth increases $1 trillion to $100.8 trillion at the end of March

  • Retail sales jumped 0.8% last month, 0.4% was expected

  • Trade balance deficit lower by almost $3 billion boosting Q2 GDP

Negatives

  • Consumer credit growth slowed last month to $9.2 billion, $14 billion was expected

  • Industrial production declined 0.1% last month, 0.2% was expected

  • MBA mortgage applications declined month-over-month continuing a weak trend

 

EQUITY OUTLOOK

Summary
 

Equity markets generally lacked direction in June as participants struggled to weigh rising global trade tensions against the backdrop of a fertile business environment. The S&P 500 finished the month up 0.7% though there was no clear leadership. Growth stocks once again outperformed value with the Russell 1000 Growth Index adding 1.0% relative to the Russell 1000 Value, which was up just 0.2%. However, from a sector standpoint the picture looks a little murkier. The all-important, growth-laden technology sector fell 0.4% and the best two performing sectors were real estate and staples, traditional value sectors, both climbed 4.5% in June.

Continued trade disputes seem to have weighed more heavily on international equity markets with the first round of tariffs between the U.S. and China taking place in early July. For the month of June, the MSCI EAFE Index declined 1.2% and the MSCE Emerging Markets Index fell 4.1%. A firming U.S. dollar, which rose 0.5% for the month, also contributed to international equity underperformance.

We continue to believe the markets will remain rudderless through the middle part of the year struggling to gain much momentum in either direction. The scale of stimuli such as the tax cuts and regulatory changes will overshadow the media-fueled trade concerns, which will eventually quiet down. Corporate earnings are expected to surge over the next several quarters and the conclusion of the election later this year (whatever the outcome) should provide a nice platform for equity markets to ascend.
 

Positives

  • Strong outlook for corporate revenue and earnings

  • Consumer and business confidence remain elevated

Negatives

  • Continued trade tensions

  • Rising wages and input costs
     

FIXED INCOME OUTLOOK

Summary
 

In a surprise to no one, the Fed increased the overnight lending rate on June 13th by another 25 basis points (bps). This was the seventh rate increase since December of 2015 and the second of this year. In anticipation, treasury yields moved about 10 bps higher across the curve since the end of May and recovered about one-half of the plunge experienced in mid-May when Italy once again exposed the fragility of the European Union. What did come as a surprise to the market was the release of the Fed’s “dot plots” indicating their central expectation for four rate hikes this year, up from their previous expectation of three.

With the Fed moving rates higher and sooner, many would have expected yields to go up across the entire curve, but after the Fed’s announcement there was a collective yawn, and rates began to trend sideways to slightly lower through the end of the month. The 2-year finished the month about 10 bps higher at 2.53% and the 5-year ended about 4 bps higher at 2.74%. The 10- year ended essentially unchanged at 2.86%, continuing the long curve-flattening trend, and the 30-year bond dropped 4 bps to end at 2.99%. By any measure the curve is the flattest since late summer 2007, about a year and a half after the Fed inverted the curve by increasing the overnight rate (by 25 bps at 17 consecu¬tive meetings) and just before the financial crisis ensued and the Fed slashed rates to near zero.

Inverting the curve is seen as an ominous precursor to the economy stumbling and a recession ensuing. Yet is it the inverted curve that causes a recession, or do higher rates lead to tighter financial conditions which cause investors to anticipate a recession and, in turn, buy longer maturity bonds to hedge riskier assets? As with the classic “chicken or the egg” parable, in the end, it really matters little. More times than not, an inverted curve leads a contraction in the economy even though causality might not be there. Historically, bond investors have been pretty good at letting the Fed know when they have gone far enough with rate hikes, and we bet that the new market savvy Fed Chairman Jay Powell listens.

If there are no more than four more rate hikes over the next 12 to 18 months as we expect, then the 2-year is appropriately priced for now. It will still edge higher over time, but slowly. The 10-year had trouble holding above 3%, even with no evidence of a slow down on the horizon. It should eventually move just above that level, but we are not concerned that inflationary pressures will overshoot and cause long rates to move sharply higher. Corporate credit spreads continued to move higher in May, but at about 110 bps in aggregate, we still believe that investment-grade corporate bonds represent a good relative value.
 

Positives

  • Emerging market and European weakness crack the synchronized global growth story

  • Trade wars could slow world demand

  • Inflation is back at the Fed’s target, but not above

Negatives

  • Trade wars could lead to higher inflation in certain industries

  • The Fed’s rate hiking cycle will continue as long as the markets remain fairly stable

  • Another quarter of negative bond returns could spook investors into selling

Unknowns

  • Mid-term elections could alter the ability of the administration to promote agenda

  • Relations with major trade partners remain fluid and could sour

 


 

Contact HomeStar Trust for questions or to schedule an appointment:
Jackie Bruhn, Trust Officer
(815) 935-2184
JBruhn@HomeStarBank.com

 




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Copyright 2018 by FCI Advisors. This material has been prepared for information purposes only. Factual materials obtained from sources believed to be reliable but cannot be guaranteed.