A Review of Summer 2018 Markets

 

Let’s begin with the market update and catch ourselves up with what transpired this summer.

Starting off with major indices, since the official end of the Spring term on May 24:

  • The S&P 500 rose 5.39% (147 points) to 2874. This marks a new record high for the index.

  • The NASDAQ Composite rose 7.03% (522 points) to 7,946.

  • The Dow Jones Industrial Average rose 3.94% (978 points) to 25,789.

  • The Russell 2000 rose 5.96% (97 points) to 1,725.

Data as of August 24, 4:00PM

On to other economic indicators, the unemployment rate fell to an 18-year low of 3.8%, and gross domestic output grew at an impressive 4.1% annual rate in the second quarter, with the final year projection set to be 3%. The P/E ratio over the summer clocked in at around 18.8x as opposed to 21x highs in February. This has been primarily due to huge earnings growth in this quarter.

If there’s one word to mention, it’s “tariffs.” President Trump continued addressing his trade deficit campaign promises by instituting tariffs on Chinese goods, now totaling $50 billion. There are on-going discussions to set tariffs as high as 25% on an additional $200 billion, which if approved, are thought to be instituted in September of this year. China retaliated, placing tariffs on $50 billion worth of American goods. China hasn’t been the only target of the Trump Administration; the European Union, Mexico, Turkey, Japan, and many other countries have been targeted.

Markets have been sensitive to the tariff developments, and fear of a full-out trade war, and a subsequent drop in international trade, has put downward pressure on the markets. With every talk, threat, and speech, markets have bounced back and forth between optimism and despair. It will be interesting to see how this whole debacle unfolds.

The other major headline this summer has been interest rates, specifically the Fed raising the Federal Funds Rate, the interest rate that depository institutions charge each other for overnight reserve balance lending. In mid-June, the Fed announced their second hike, raising the rate a quarter point, to a range from 1.75% to 2%. The Fed Chairman Jerome Powell cited that strong growth and labor markets, tied with a close-to-target inflation levels were some of the drivers behind the decision. Rate hikes are a preventive measure to keep the economy from overheating and causing high inflation. However, the compromise is slowing down economic growth. Following the news, the stock market fell, as investors expect that higher borrowing costs will negatively impact earnings. There are currently two more projected interest rate increases for 2018, and with a September rate hike to 2.00-2.25% at a 96% chance.

The 10-year treasury note, an important confidence indicator, proxy for other interest rates, and widely observed financial instrument, had a yield between 2.82% and 3% over the past three months. Trade tensions and recent emerging-market economy concerns applied downward pressure to the yield, however, the guilty plea of Michael Cohen, President Trump’s former lawyer, over campaign-finance violations spiked yields. The current 10-year treasury yield sits at around 2.83% as of 4:00PM, August 24th, 2018.

Moving on to the yield curve, the curve formed by plotting treasury yields with respect to their maturities has markets talking. Typically, longer term yields are higher than shorter-term ones to compensate investors locking up their money for longer. However, the gap between those yields is closing, or in other words, the yield curve is “flattening.” This has led to a drop in financial stock prices, whose earnings will be negatively affected. There is also a fear that there will be an “inversion of the yield curve,” which occurs when short-term yields surpass long-term yields. Historically, inversions have been correlated with upcoming recessions. Could an approaching inversion be a harbinger?

In world news, Turkey and Venezuela have been grappling with out-of-control inflation. Turkey’s CPI increased by over 15% on the year, and with President Maduro’s program, the International Monetary Fund is prediction and inflation rate over 1,000,000% by the end of the year.

Lastly, to end with miscellaneous noteworthy news, Apple is the first company to hit the coveted one trillion-dollar market value mark. Amazon and Alphabet are approaching as well. Elon Musk tweeted that he was considering taking Tesla, the most shorted stock in the US on a dollar-basis, private (securities fraud?). He later abandoned the idea. Amazon announced it will diversify into healthcare, through its one billion dollar acquisition of the online pharmacy PillPack. AT&T is acquiring Time Warner, valued at around $80 billion. Microsoft acquired Github for $7.5 billion.

By Sean O’Dea, Karol Rychlik, and Paul Menestrier - Portfolio Management Analysts, Baruch Investment Management Group