Third Quarter 2018 Market Review
Updated: Jan 17, 2020
This quarter marks the tenth anniversary of the great recession and the economy has continued to be strong, with the lowest unemployment rate in history. Today, confidence is high but recent market fluctuations remind us how quickly things can change. It is also a reminder that subtle changes in the direction of fundamental data can lead to significant moves in the markets.
Prior to October, the stock market continued to climb as investors focused on low unemployment, strong corporate earnings, economic growth, and robust consumer and business spending. In fact, the stock market posted its 8th consecutive quarterly gain. New highs were seen across most sectors, with information technology and health care stocks leading the way. The U.S. economy has been in a slow and steady economic recovery since 2009, and the stock market has had the longest period of uninterrupted gains in American history. The elongated business cycle has been fueled by many factors including unprecedented monetary policy, and more recently fiscal policies of the current administration.
Contributing to market growth has been companies raising dividends and buying back shares of stock. During the second quarter, dividends for S&P 500 companies totaled $111.6 billion—a new record and up over 7% from the first quarter. The S&P reports that through the end of the 2nd quarter, companies continued to funnel their excess cash to buybacks, which are up 49.9% from a year ago, also setting a record for any 12-month period. Dividend increases and share buyback increase demand for equities and often lead to higher share prices. The consensus is that both increase dividends and share buy backs have been fueled by tax reform, and the benefits from corporate tax cuts may be fully priced in at this point.
Coming into the third quarter, investors were breathing easier over trade agreements between the United States, Mexico and Canada, which has been one of the market risks we have been citing all year. However, trade tensions continue to brew with China, with a tariff rate scheduled to increase in January if a deal cannot be reached.
As expected, the Federal Reserve raised rates for the third time this year In a change from our second quarter commentary, the Fed does appear much more hawkish and has expressed that there could be many more hikes, which can be a red flag for equity investors. Rate hikes contribute to our optimistic yet cautious outlook moving forward and we expect higher volatility as long as we continue to see monetary policy tightening. We also saw yields go up across the curve through the third quarter, causing more demand for Treasuries. We continue to monitor the continued risk of the flattening of the yield curve, which is why we have focused on higher quality fixed income with shorter maturities.
The current stock market pullback is not surprising given all that has transpired this year. Monetary policy being less accommodative, slower growth globally and a mid-term election year should all contribute to continued volatility in the markets. While there are always current events that have impact on asset prices, the primary risk remains the economy. While healthy, we are in the later stages of the business cycle and it cannot last forever. All of these factors discussed, reinforces that investors should not become complacent and be more cautious moving forward.
In volatile periods, investors should maintain broadly diversified portfolios and not simply pursue the hottest trends of the year. While not always popular, broadly diversified asset allocation is important and we want to continue to educate our clients and help them navigate this environment. Investors benefit from maintaining portfolios that include cash and high-quality fixed income that provides some diversification from equities. Investors should also have a balance between growth and dividend-oriented equity allocations. Portfolio asset allocation adjustments are best considered in line with your goals and risk tolerances and not based on predicting short-term moves in asset prices. We would prefer making shifts in allocations when necessary and not as a result of, or during major market moves.
The bottom line is to be mindful. We always focus on where you are in life and your goals, and work hard to make sure that your portfolio asset allocation is reasonable for your time horizon, goals and risk tolerance. This is why we spend so much time during client meetings on educating our clients – about diversification strategies and proper asset allocation. We urge our clients to communicate any concerns they may have, which includes potential needs for cash from the portfolio in the short-term. We never want a forced liquidation of assets when prices are not favorable.
As always, please feel free to reach out with any questions.