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Second Quarter 2018 - Pinnacle Investment Management, Inc.

Second Quarter 2018

July 11, 2018 / Quarterly Newsletters

The first half of 2018 was bumpy for financial markets as trade tensions took their toll.  The S&P 500 began the year with its best start in over 30 years.  It gained 7% the first three weeks before encountering the fastest 10% decline since the 1920’s but rebounded to close the first half of the year with a gain of 2.7%.  International markets experienced a similar ride during the first quarter, but due to escalating trade tensions did not rebound, and in aggregate lost 3.5% during the first half of the year.  Emerging markets were impacted even more by rising trade tensions, and on average declined nearly 9% during the recent quarter.  The best performers were US Small companies and technology stocks which would not be impacted as much as large industrial firms in the event of a trade war.


The Federal Reserve raised short term interest rates by 0.25% in both March and June (to a range of 1.75% to 2.0%), an indication that the Fed believes the US economy is making progress toward its objectives of full employment and price stability. Many economists expect the Fed will raise rates one or two more times in 2018 and continue raising them in 2019.  As a result of a strengthening economy the interest rate on ten year US Treasury bonds rose from 2.4% at the beginning of the year to 2.8%.  Rising interest rates create a headwind for bond investors and the US aggregate bond index lost 1.6% in the first half of the year.


Returns for key indexes were:

  1st Qtr


2nd Qtr


1st Half


Dow Jones Industrials index 2.0%   1.3% 0.7%  
S&P 500 index 0.8% 3.4% 2.7%  
NASDAQ 2.3% 6.3% 8.8%  
S&P 400 mid-cap index 1.2% 3.9% 2.7%  
Russell 2000 small-cap index 0.1% 7.9% 7.7%  
Total International, excluding US 0.2% 3.3% 3.5%  
Dow Jones Global Stock index 1.4% 0.1% 1.5%  
Barclays US Aggregate Bond index 1.5% 0.2% 1.6%  



 Economic and Market Outlook   The recent reduction in the US corporate tax rate is contributing to positive earnings growth and US corporate profits are expected to grow nearly 20% this year, making US stock valuations more attractive.


The US economy appears healthy and resilient, and economic growth is improving.  Interest rates remain low by historic standards and the US job market continues to strengthen.  Although employers hired 213,000 workers in June, 600,000 new workers reentered the workforce, so ironically unemployment rose to 4.0% from 3.8% in May, the lowest level since April 2000.  (The lowest unemployment rate in US history was 2.5% in May and June 1953.)  The Federal Reserve’s goal is to raise interest rates sufficiently to avoid inflation but without increasing unemployment or tipping the country into a recession and so far they are on track.  Inflation is currently running approximately 2%, which is the Fed’s target.  However new trade tariffs will increase costs to consumers and businesses.  If inflation creeps higher the Fed is likely to raise rates faster.


In addition to raising interest rates, the Fed is accelerating its reduction of the $4.5 trillion in US Treasury and mortgage securities they acquired during the financial crisis under a program termed QE (“Quantitative Easing”).    Some economists have concluded that QE had very little effect on the economy so it is reasonable to conclude that the QE reversal will also have limited impact.


The Fed Reserve’s moves to increase short term interest rates, the reversal of QE and a strong labor market, make it extremely likely that both short term and long term interest rates will continue to rise through 2018 and into 2019, creating a headwind for both stocks and bonds.


Although the US economy is growing, there is a good deal of economic and market uncertainty resulting from US trade policy. Arguably every respected economist believes that free trade is vital for economic growth and that raising tariffs are likely to increase costs for consumers, stifle economic growth and result in counter-tariffs being imposed by countries importing US merchandise.  While it is unlikely that every trade agreement the US has entered into is equally fair to both parties, imposing new tariffs will likely upset the equilibrium and lead to undesirable consequences.    Harley Davidson’s announced plans to move some production overseas to avoid European tariffs imposed in retaliation of the new US tariffs on steel and aluminum is a visible example of the unintended consequences that may result from imposing new tariffs.  Investing during a period of rising tariffs is very challenging since it is impossible to know which products might be targeted, how low long the tariffs will last, and their impact on complex global supply chains.  As a result, market volatility is likely to continue for as long as Washington’s policies threaten free trade.


While there is likely to be differences of opinion as to whether a particular trade agreement is fair to both sides, there are unlikely to be differences of opinion whether it is fair for one country (such as China) to use espionage, counterfeiting and hacking to steal trade secrets and intellectual property. It is very important to US corporations and our national security to find a way to halt these practices.


A new concern is that the difference between short term and long term rates is small and continuing to narrow. When the economy is growing, the rate on longer term bonds are typically higher than short term ones to provide investors with additional compensation for the risk they are taking.  Historically when short term rates exceed long term rates (sometimes termed an “inverted yield curve”) it has often preceded a recession by six to 24 months.  According to the NT Times, this has occurred in advance of each of the 9 recessions since 1955 and has only provided one false positive.  Currently the difference between the yield on two year US government bonds and ten year bonds is only 0.3%.  It will be prudent to keep our eyes on interest rates.  Even if the yield curve does invert, it is important for investors to remember that recessions do not necessarily result in a bear market.


Both developed and emerging overseas markets are more attractively valued than the US. While international stocks would also likely suffer in a trade war, the valuations make them attractive.


The US Treasury uses “Enron like Accounting” for our national debt.   According to official figures, the US National Debt stands at a relatively high $21 trillion or 108% of our GDP.  But according to the non-profit “Truth in Accounting” government reporting is similar to the infamous Enron accounting methods which omitted huge liabilities.  While the US Treasury reports our current debt at more than $21 trillion, this is only correct if you believe that our veterans and Social Security participants are not owed all the retirement benefits they have been promised.  If unfunded Social Security and Medicare liabilities as well as veteran retirement benefits are included, our national debt increases fivefold to more than $104 trillion.  The current accounting method works well for elected officials who want votes and make promise,  however it obscures growing financial problems down the road.


Scammers are always on the prowl, both on-line, on the phone, in person and by mail. So be careful.

  • Always verify a caller’s identify before providing any information. The IRS does not initiate contact by phone.
  • Monitor credit card bills and bank statements for erroneous charges
  • If there is a possibility that your personal information has been compromised, freeze your credit
  • Do not click on any email links unless you are absolutely certain it is from a legitimate source
  • If you see a “pop up” message that your computer has a virus, it is likely to and an attempt to have you call a phony “support” number. Simply close that window and clear your browser’s history.
  • If you believe that your bank or investment account data has been compromised, notify the financial institution.

About the author

John Eckel: CFP®, CFA is President of Pinnacle Investment Management Inc. of Simsbury. He has been included in BusinessWeek.com’s list of the Most Experienced Independent Financial Advisors, has been named four times to Worth Magazine’s list of Top Financial Advisors, included twice in Medical Economics list of Top Financial Advisors for Doctors and named twice in JK Lasers list of Top Professional Advisors for Baby Boomers.

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