We’re half way through 2018, which is a great time to take a look at where we are and where the rest of the year may take us. As you’ll see, between the noise of the “trade wars,” and where things stand with the broad markets, this really is an interesting point in the overall cycle.
The “trade wars” caught everyone’s attention in May, and as noted in our related blog post, these are never a good thing. Many of us were hoping this was merely saber rattling, but the situation has escalated quickly with many of our key trading partners pulled into the fray along with the US economy. In a nutshell, trade wars are bad because they always have unintended consequences. It started with trying to make US steel and aluminum producers more competitive by making foreign imports more expensive. Now we’re seeing an impact on soy bean farmers, companies like Harley Davidson, and enough other examples that the impact is now being viewed in terms of how much it will impact the overall economic output of the country (think GDP).
The S&P 500 is close to where it was at the beginning of year. A key metric related to stock prices is the price-to-earnings ratio. This essentially tells you how much it costs to buy what a company earns. For large companies this number historically averages around 17, and right now that number is around 24. In order to return to a long-term average corporate earning need to go up, stock prices need to come down, or some combination of the two would need to occur.
Fortunately, corporate earnings have been strong, which has helped keep the market hovering where it has been all year, and this trend is expected to continue for the time being. However, there doesn’t appear to be much room for prices to move up given that these strong earnings simply have the market treading water. Many companies have been buying back their own shares, which has also helped support the market.
In the world of bonds, the Fed has been getting much of the attention. The Fed’s job is typically seen as trying to keep unemployment down while also keeping inflation under control. Unemployment is extraordinarily low right now, and inflation is finally increasing after years of sitting stubbornly low. The Fed’s natural response has been to increase interest rates to keep inflation in check, higher rates increase the cost of doing business acting like a brake on the economy.
In January the Fed was expected to increase interest rates three times in 2018, and now that expectation has moved to four increases. It’s important to note that the price of bonds drop as interest rates go up, which means bond portfolios could lose some value. While this is typically not as dramatic as the ups and downs of the stock market, it’s important to be aware of this relationship.
Yes, Things are Interesting Right Now
The stock market is expensive based on historical values, and moving sideways during a period of strong corporate earnings. The bond market is under the natural pressures created by increasing rates and inflation. And, we have the “trade wars” that don’t seem to be going away any time soon. At this point there seems to be some consensus among big banks and economists that the next recession will occur in 2020, but this is a moving target and estimates are likely to change.
Things are very interesting right now. We always feel that the best way to navigate any environment is through careful planning and allocating between stocks and bonds in a way that is appropriate for your age and risk tolerance.
Even if you’re not a client, we are happy to answer questions about the markets in general, or related to your personal financial situation. We love questions, never hesitate to reach out!