Halfway through 2018, the economy is performing well – economic indicators are strong, consumer spending is solid, corporate earnings are exceptional and the Fed continues to take steps to tighten policy. Year to date through June 30th, the S&P Index increased 2.6% and the FTSE All World Ex-US Index decreased -3.7%. For the quarter, the S&P 500 Index was up 3.4% and the FTSE All World Ex-Us Index declined -2.58%. Going forward, investors are keeping an eye on the yield curve, the potential escalation of a trade war and an economic slowdown.
Capital Markets Review
January 1, 2018 – June 30, 2018 index returns:
S&P 500 (U.S. Large Cap): 2.6%
Russell 2000 (U.S. Small Cap): 7.7%
MSCI EAFE (Developed International Markets): -2.4%
MSCI EME (Emerging Markets): -6.5%
Barclays Capital Aggregate (U.S. Fixed Income): -1.6%
Barclays Global High Yield Index: -2.5%
Bloomberg Commodity Index: 0.0%
The U.S. economy is in its 10th year of a bull market and is still strong. We believe this “heating up” of the economy is short lived and we should see a “cool down” in late 2019. Total nonfarm payroll employment increased by 213,000 in June, and the unemployment rate rose to 4.0%, according to the U.S. Bureau of Labor Statistics. Though the unemployment rate rose, we do not see this as a negative, as there were 601,000 people who entered the labor force. Real gross domestic product (GDP) increased at an annual rate of 2.0% in the first quarter of 2018, according to the third estimate released by the Bureau of Economic Analysis. In June, the ISM manufacturing index increased to 60.2, from 58.7, which is close to the 14-year high of 60.8 in February. This increase is a signal that strength in the U.S. economy is offsetting investor uncertainty on trade policy. The ISM non-manufacturing index rose to a 13-year high in June, from 58.6 to 59.1, which points to strong domestic demand.
The yield on the 10-year U.S. Treasury rose in 2018, and we expect it to rise more this year. Inflation should rise slightly, but we are currently above the Fed’s inflation target. Many investors also wonder whether the yield curve may invert and what that means for the economy. An inverted yield curve is an environment where long-term debt instruments have a lower yield than short-term debt instruments. The yield curve is more likely to invert with each rate hike (typically 25 basis points each). In the past, an inverted yield curve has been a reliable indicator of recession, since it indicates that the Fed may cut rates in the future.
As mentioned above, we believe the economy will cool down in 2019 – because of continued rate hikes by the Federal Reserve, a slowdown in fiscal stimulus, and a lack of supply of workers. The Fed will likely continue to tighten policy with 4-5 more rate hikes in 2018 and 2019, which will slow the economy. As fiscal stimulus efforts (like the Tax Cuts and Jobs Act of 2017) pour into the economy, the federal deficit continues to grow. When the fiscal stimulus slows, then the deficit stops growing, indicating a slowdown. Finally, we have a lack of supply of workers in the U.S., which will affect job growth. The population of 18-64-year-old workers and both illegal and legal immigration are decreasing.
Global manufacturing remains strong, with many regions experiencing double digit earnings growth. In the eurozone, economic growth and earnings are solid and credit growth is rising. We see political risks in Italy and within Brexit negotiations that will need to be monitored going forward. In the Asia Pacific region, growth looks favorable and earnings expectations are upgraded. However, risks remain in the region such as trade tensions and a rise in the U.S. dollar.
As seen above, international returns have lagged U.S. returns this year, which is a marked difference from 2017, where international returns outperformed U.S. returns. We believe that there is still space for growth in international markets due to earnings growth and lower valuations relative to U.S. equities. We also see room for economic growth in emerging markets. Specifically, the middle class in emerging markets has grown exponentially and is now contributing to those economies in meaningful ways.
Investors have watched blazing headlines on tariffs, and it’s important to remember that there is a large difference in what’s being discussed in the media, and what has actually been enacted. The amount and number of tariffs are still low. The impact of tariffs is manageable and the economy can withstand them.
Economy and Our View
The U.S. economy is benefiting in 2018 from fiscal stimulus, but the rewards could be short-term. Eventually, we feel that the increases in our federal deficit resulting from the tax cuts and increased spending will hinder growth in future years. Though uncomfortable for investors to think about, the economy may slow and there is an increased probability of a recession in the next few years. It’s important to remember that a recession doesn’t mean Armageddon, and the next recession will likely be much milder than the 2008 financial crisis, which was a black swan type of event. The performance dips from market corrections or recessions are manageable in a balanced and globally diversified portfolio, which is what Callan Capital strives to build for clients. In addition, it’s important to remember that recessions are difficult to predict, so a long-term perspective is important.
We continue to monitor the global economy and seek opportunities to invest in certain sectors and geographic regions given the current market environment. In our view, a long-term investment horizon, asset allocation, diversification and discipline remain crucial to portfolio success. If you are a client and would like further detail on these topics or anything else, please call or email us. If you are not a client, but would like more information on Callan Capital’s wealth management services, please contact us at (858) 551-3800 or www.callancapital.com.
 Global Market Outlook, Russell Investments, June 30, 2018. https://russellinvestments.com/us/global-market-outlook
Data are as of July 10, 2018
Past performance does not guarantee future results.
Diversification does not guarantee investment returns and does not eliminate the risk of loss.
The S&P 500 Index is widely regarded as the best single gauge of the U.S. equities market. This world-renowned index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Although the S&P 500 Index focuses on the large-cap segment of the market, with approximately 75% coverage of U.S. equities, it is also an ideal proxy for the total market. An investor cannot invest directly in an index. Indexes are unmanaged.
The FTSE All-World ex US Index is one of a number of indexes designed to help investors benchmark their international investments. The index comprises Large and Mid cap stocks providing coverage of Developed and Emerging Markets excluding the US. The index is derived from the FTSE Global Equity Index Series (GEIS), which covers 98% of the world’s investable market capitalization.
Russell 2000 Index: An index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States.
EAFE Index: An index created by Morgan Stanley Capital International (MSCI) that serves as a benchmark of the performance in international index has been in existence for more than 30 years.
EME Index: An index created by Morgan Stanley Capital International (MSCI) that serves as a benchmark of the performance in global emerging markets. It is a float-adjusted market capitalization index that consists of indices in 21 emerging economies.
Barclays Capital Aggregate Bond Index: An index maintained by Barclays Capital, which took over the index business of the now defunct Lehman Brothers, and is often used to represent investment grade bonds being traded in United States. It is an unmanaged index considered representative of fixed-rate, noninvestment-grade debt of companies in the US, developed markets and emerging markets.
The Bloomberg Barclays Global High Yield Index: The Bloomberg Barclays Global High Yield Index is a multi-currency flagship measure of the global high yield debt market. The index represents the union of the US High Yield, the Pan-European High Yield, and Emerging Markets (EM) Hard Currency High Yield Indices. The high yield and emerging markets sub-components are mutually exclusive.
Bloomberg Commodity Index: A broadly diversified commodity price index distributed by Bloomberg Indexes. It tracks prices of futures contracts on physical commodities on the commodity markets. The index is designed to minimize concentration in any one commodity or sector. It currently has 22 commodity futures in seven sectors.
Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
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Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services.
The views expressed are those of Callan Capital, LLC. They are subject to change at any time.