In the second quarter of 2018 investors were caught in the middle of a battle between global growth and geopolitical tensions. While the U.S economy is growing solidly with GDP at 3%+ corporate earnings coming on a quarterly basis of 20%+ boosted by tax cuts, the Fed continued to tighten or raise rates which contributed to reducing global liquidity and a stronger dollar.
As a result the clear winners were the U.S. stocks, up 3.4% as evidenced by the S&P 500 and small stocks which were up 7%+ which are less exposed to global trends and trade risks. The rising U.S. dollar provided a headwind for non-U.S. assets and emerging markets equities suffered the biggest losses.
As for the bond market, we are in a rising interest rate environment and during the quarter U.S. interest rates ticked up modestly resulting in weak returns across most bond categories.
The biggest potential change facing the economy is the evolving rhetoric surrounding trade, the imposition of tariffs, and retaliatory tariffs, and the potential for a wider trade war. At this point it is difficult to determine whether this trade rhetoric is simply a negotiating tactic and all sides will ultimately work toward a fair trade outcome or whether a trade war develops which would have widespread repercussions ultimately increasing inflation and slowing global growth.
The current economic expansion is nine years old. Economists are not calling for a recession anytime soon. They expect the Fed will continue to raise rates, although gradually, as inflation has thus far been around 2%. Until inflation accelerates we expect the economy to continue to expand and the U.S. stock market is likely to grind higher.
We continue to look for opportunities within the fixed income market, as well as the stock market. Recently, we initiated positions in the high-yield municipal bond market and depending upon how the potential trade war develops we are looking to selectively add to our international exposure as is it significantly less expensive than the U.S. markets.