Gill Capital Partners July 2018 Market Commentary
Q2 2018 Market Review
The second quarter of 2018 delivered mixed returns across the asset class spectrum as markets worked to digest escalating trade tensions, a stronger U.S. Dollar, a strong U.S. economy, and higher inflation. This complicated mixture of underlying economic drivers combined to push U.S. equities higher with the S&P 500 Index returning 3.43% for the second quarter, pushing the index higher by 2.65% for the year. The leader amongst equities so far in 2018 is small caps, which returned 7.75% in the second quarter and are now up 7.67% for the year as measured by the Russell 2000 Index. The stronger dollar presents a double whammy of sorts for international and particularly emerging market companies. A stronger U.S. Dollar generally translates into weaker commodity prices, and many emerging market companies are involved with or exposed to the commodity industry. Secondly the cost of their liabilities are generally denominated in U.S. Dollars. A strengthening U.S. Dollar therefore increases their borrowing costs. The strength of the U.S. Dollar so far in 2018 has translated into relative and nominal weakness in international and particularly emerging market equities. As you can see in the chart below, these are the weakest two equity asset classes so far this year with emerging markets down 7.78% in the second quarter and 6.60% for the year as measured by the MSCI Emerging Markets Index. Developed international equities also posted negative returns in the second quarter, as they were down 0.89% in the second quarter and are down 2.40% for the year as measured by the MSCI EAFE Index.
The escalating trade tensions between the U.S. and nearly all of our trade partners this year has been driven by protectionist policies initiated by the U.S. the likes of which we have not seen in many decades. What is the Trump administration trying to accomplish, and what has happened thus far? President Trump’s goal is to reduce the U.S. trade deficit with our major trade partners such as: China, Europe, and Mexico, while also attempting to address the theft of intellectual property particularly on behalf of China. Thus far, the Trump administration has announced tariffs (a tax on a product made abroad) on over 1,100 product lines representing an estimated $34 Billion in goods largely from China, and to a lesser extent the EU, Mexico & Canada. The first of which took effect earlier this month. China has responded in an equal fashion imposing tariffs on $34 Billion of U.S. exports to China. The tariffs were placed on various U.S. exports ranging from soybeans to cars. Will the escalation in trade tensions threaten the global growth environment?
Our belief continues to be that the Trump administration’s hard line stance is more posturing and negotiating than it is policy. While, the first round of tariffs has been implemented it is a relatively small amount compared to what has been announced. We believe that the Trump administration and the Chinese government understand the ramifications of a full-blown trade war, the consequences of which would be negative for all involved. Therefore, the logical conclusion is that this is a hard line negotiating position aimed at a few targeted wins that the administration has identified namely: opening of the financial sector in China, Chinese investment in the U.S., more agricultural imports into China and others. What comes next will be very telling, as the likely scenario remains that a deal will be reached allowing both sides to pronounce political victories and this will have amounted to some minor saber rattling. On the other hand, if we see further escalation of trade tensions accompanied by continued retaliatory actions, then we will become more concerned. At this point we continue to hold market allocations within our portfolios to international and emerging market equities, as valuations are attractive, and they provide an important element of diversification to portfolios. However, we are watching this closely, and will recommend adjustments if we believe they are warranted.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.