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Ferris Capital is incredibly proud of our many community engagements and contributions to charitable organizations around the country. This blog is intended to share these many achievements as well as notable news from within the Ferris family and important financial updates that could affect our clients. Please check back often and don’t hesitate to call us if you’d like more information on anything you see here.

July 16, 2018

Second Quarter Recap & Investment Outlook

Despite consistently strong corporate earnings across the board, volatility continued during the second quarter as Wall Street was driven by very public trade negotiations from the Trump Administration. While we believe that President Trump’s approach to bargaining often involves making the other side uncomfortable and asking for too much before moving back to the middle to get a deal done, the rhetoric has certainly spooked the capital markets as trade wars are generally not a positive for stocks. Nevertheless, domestic stocks still posted gains over the quarter with the S&P advancing by 3.43% on the strong earnings results stemming from the recent tax reform.

However, the performance of the stock market was not widespread. Most companies saw little movement in their share prices and a handful of names were responsible for almost all of the upside performance. In fact, three stocks (Amazon, Netflix, Microsoft) were responsible for 71% of the S&P’s YTD return. If we expand the list to also include Apple, Alphabet and Facebook, 98% of the S&P’s YTD Return was attributed to six stocks. In all, the top 10 performers in the index contributed 122% of the overall return as illustrated in the chart from Goldman Sachs below.

7.16.18 Pic 1.jpg

Outside of a few select technology companies driving the S&P 500 returns, companies were largely constrained by tighter economic conditions. Borrowing costs have increased with rising interest rates. A surge in oil prices (oil has moved from $48/barrel to over $70/barrel in the past twelve months) has increased energy costs and a tight labor market has begun to increase pressure on wage costs. There has also been in uptick in commodity costs across the board leading to additional inflationary pressures for producers. These structural headwinds have essentially negated the effects of the tax cuts on many companies as the earnings effect was already priced into the market.

With the increased earnings and sideways trading, we also saw valuations return closer to historic norms. As a result, the equity markets are not as expensive as they were as recently as last fall. 

Abroad, international stocks fell on trade and tariff fears as well as political turmoil in Italy. Financials and automakers were particularly hard hit and the MSCI EAFE Index dropped 1.54% over the quarter. We anticipate further volatility as weaker economic conditions still prevail and political risks have increased both through internal EU turmoil as well as potential tariff implications.

The dollar saw considerable strength over the quarter (gaining 5%) which reversed its fall since the Trump election. Increased dollar strength impacted emerging market stocks the most and they fell 8-10% over the quarter while emerging market bonds also fell approximately 3%. Emerging market countries and companies are very debt driven and an increase in the dollar translates to higher payments as most of their borrowing is done in dollars. Conversely, emerging market stocks performed extremely well over the period when the dollar fell 15% immediately after Trump’s election.

As expected, the Federal Reserve raised rates again in June in response to low unemployment rates, the economy being in “great shape” and signs of inflation. The new Federal Reserve Chairman, Jerome Powell, also hinted at another two raises over the remainder of the year. These rate increases have continued to push the bond market lower with the Barclay’s Aggregate Index falling .16% bringing it to -1.62% on the year. However, the overall yields over the quarter remained somewhat stagnant after climbing for two years with the 10 Year Treasury offering yields of 2.73% to start the quarter, briefly climbing above 3.1% in May and finishing the quarter at 2.85%. Additionally, while shorter term rates rose with the Fed action, the longer term maturities did not which has led to a flattening of the yield curve which has historically been a signal that a recession may be on the horizon.

Major Index Returns for the First Quarter of 2018

  • S&P 500 Index (Large Cap Stocks): 3.55%
  • Russell 2000 Index (Small Cap Stocks): 7.75%
  • MSCI EFAE Index (International Stocks): -1.24%
  • Barclay’s Aggregate Bond Index (Fixed Income): -.16%

Outlook

Domestic Stocks

We expect market volatility to continue or even increase as the blustery rhetoric around trade policies likely ramps up before calming down, but with domestic stocks generally advancing into the year end. As the discourse and unintended consequences are seemingly unpredictable, domestic stocks should experience fits and starts as we move forward. That being said, economic conditions are good and growth should continue. Consumer and business sentiment also remains strong. Lastly, we are seeing considerable capital expenditures which should help propel the economy into 2019. Accordingly, we are maintaining our exposure to domestic stocks and may shift some of the hedged equity in our alternative sleeve to more market oriented investments. Absent a Fed policy error or an escalation in a trade war with China and/or Europe, we see domestic stocks heading higher in the near term.

International Stocks

We expect to reduce our exposure to international stocks in the early part of the third quarter as the trade and political uncertainties make the overweight allocation less attractive given the soft growth in Europe that we are seeing. However, we still feel that international equity may outperform domestic equity in the next 2-3 years as the companies are trading at more attractive valuations and the prospect of political risk decreasing. We will still maintain a solid weighting, but will look to cut back from the current weighting due to the continued risk. We are also monitoring the emerging markets equities for an entry point. The recent dollar strength and trade negotiations have reduced valuations, but we would like to have a better sense that the trends are reversing before buying into the space.

Fixed Income

We expect rates to continue to rise given the low unemployment rate, strong earnings, prospects of inflation and the expectation that the Federal Reserve will raise rates again in September. Given this backdrop, we expect to keep much of our bond allocations static until that point. After the Fed’s anticipated actions in September, we anticipate moving towards individual bonds via separately managed strategies. We are expecting to take on a little more interest rate risk as we feel that growth is likely to soften as we head into 2019 which will diminish the likelihood of additional Federal Reserve increases and could result in a bond market rally if the economy or stock market begin to falter.

 

 

 

 

 

 

 

Past performance is not necessarily indicative of future returns.  The performance described in this report is based on investment selections for the period in question.  There is no guarantee that these same investments will continue to perform as described.  All investing carries a risk of loss, including principal that clients should be prepared to bear.  Clients are advised to inform us of any changes in their circumstances as such changes may materially alter the appropriateness of the investments selected by Ferris Capital.