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Second Quarter 2018 | Issue No. 22
In This Issue:
Economic And Market Update
Equity Market Update
Fixed Income Market Update
An Economic & Market Commentary from Trust Point
An Economic and Market
As of Actual 3 Mths Ago 1 Year Ago
Update from Trust Point Dollar Index Level
US Economic Activity
June 94.5 90.0 95.6
ISM Manufacturing (>50=Expansion) June 60.2 59.3 56.7
ISM Non-Manufacturing (>50=Expansion) June 59.1 58.8 57.2
Non-Farm Payrolls June 213k 155k 239k
Volatility has returned this year after an abnormally calm 2017. The Unemployment Rate June 4.0% 4.1% 4.3%
fundamentals underpinning the steady advance of both equity and fixed- CPI Ex-Food & Energy (yoy) May 2.2% 1.8% 1.7%
income markets last year have slowly been losing their luster. Geopolitics Global Economic Activity
JP Morgan Global Manufacturing Index
(and trade tensions in particular) dominated the headline news in the (>50=Expansion) June 53.0 53.3 52.6
JP Morgan Global Non-Manufacturing Index
second quarter, leading to wide divergence in returns across various sub- (>50=Expansion) June 54.6 53.2 53.8
asset classes. The second half of 2018 is certainly shaping up to be an
Source: Bloomberg
interesting one for investors.
“Made in the USA” Is Back
At a recent ceremonial groundbreak- campaign promises, and markets do
ing event for Foxconn Technology not like it. The recent implementation Chart 1 : Trade tensions are putting global trade at risk
Group, a Taiwan-based company of tariffs on China and other trading
Global Exports* (%YoY)
building a large LCD panel-glass partners have been followed by the
factory in Mount Pleasant, Wis., threat of many additional ones, as
20 ELEVATED
President Trump said; “We are re- countries look to retaliate with tariffs
claiming our manufacturing legacy.” of their own. Markets are concerned 10
In recent months, Trump and his because a full-blown trade war
closest trade advisors have been busy (tit-for-tat tariffs) would likely be a 0
“standing up” to trading partners lose-lose situation for all involved,
-10
(China, in particular) that have not as it would reduce trade flows (Chart
been “trading fairly” with the U.S. The 1), growth and earnings, while also -20
administration argues that too many leading to higher inflation. Recipro-
U.S. manufacturing jobs were lost in cal concessions have been hard to -30 MRB Partners Inc © 06/2018
recent decades as a result of unfair come by so far. We remain optimistic
1990 1995 2000 2005 2010 2015
trade practices. We all remember that that negotiated solutions will be
in 2016, Trump ran on a protectionist found, but the timing remains highly *U.S. dollars, smoothed
Source: Netherlands Bureau for economic policy analysis
platform. He is now delivering on his uncertain.
Market Point Second Quarter 2018
Economic Growth: Still Healthy But Slowing
Chart 2 : Global growth doesn’t look so synchronized anymore
In 2017, global growth was strong and escalating trade tensions discussed Manufacturing PMI: U.S. *
and synchronized. Earnings were also above represent both near and long- Global Ex-U.S. ***
strong, and central banks appeared to term threats to this expansion. A full- 60
be in no rush to tighten monetary pol- blown trade war requiring a complete
icy. This year, we have so far noticed re-tooling of global corporate supply DIVERGENCE
slower global and earnings growth, chains would certainly be disruptive
50
while a few central banks have become and costly. As the U.S. economy remains
less friendly to investors. Furthermore, relatively closed, it is perceived to have
the world economy looks slightly out a greater ability to tolerate the nega-
of sync, with the U.S. still strong but Eu- tive impact of prolonged trade tension. 40
rope and China (the other two pillars of However, other countries are more de-
the world economy) facing some unex- pendent on trade and could soon suf- MRB Partners Inc © 06/2018
pected headwinds (Chart 2). We remain fer a noticeable impact on confidence 2006 2008 2010 2012 2014 2016 2018
generally confident in the resiliency of and capital spending. We are watching
the global expansion, but the tariffs closely. * Source: Institute for supply management
** Source: Markit economics
*** MRB calculation based on Markit data
Opportunities Are Getting More Difficult to Find
Chart 3 : U.S. economic expansion: Getting long in the tooth 2018-06-28
As we have discussed in previous pub- turns. The noise surrounding the pos- Length of U.S. postwar expansions (months) 120
lications, we find it increasingly difficult sibility of continued and escalating 120
Expansions defined by 106 108
to find true long-term investment op- trade tensions adds an additional ele- National Bureau of
100
portunities in the marketplace today. ment of uncertainty. However, we find Economic Research 92
For our avid readers, this comes as no little value in making investment deci-
80 73
surprise. As we slowly approach the sions based on short-term noise; the Median = 51.5 months
58
end of the current economic cycle, world doesn’t move as fast as CNBC or 60
45
which is already the second longest Bloomberg TV would have you believe. 39
37 36
since World War II (Chart 3), headwinds We are avid students of economic and 40
24
have begun to appear. We recognize market cycles, and we make decisions
20 12
that modeled portfolios have provid- based on a number of indicators and
ed our clients solid returns in recent models we have found reliable over
Expansion
1945 1949 1954 1958 1961 1970 1975 1980 1982 1991 2001 2009
years (above and beyond peer groups time. These will provide insightful sig- Starting
and passive benchmarks), but pricier nals that a change in strategy is war- Copyright 2018 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.
See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.
equity valuations and low bond yields ranted when that time comes.
should dampen future expected re-
Market Point Second Quarter 2018
An Equity Market
Major US Equity Index Level Quarter-End 3 Mths Ago 1 Year Ago 3 Years Ago 5 Years Ago
Update from Trust Point
S&P 500 2,718 2,641 2,423 2,063 1,606
Dow Jones Industrial Average 24,271 24,103 21,350 17,620 14,910
Nasdaq 7,510 7,063 6,140 4,987 3,403
Equity Returns (%) 3 Month YTD 1 Year 3 Year (Ann) 5 Year (Ann)
Global equity prices declined in the second quarter, partially offset by strength US Large Cap Growth 5.8% 7.3% 22.5% 15.0% 16.4%
in the U.S. The MSCI EAFE index was down 1.2% while the S&P 500 increased US Large Cap Value 1.2% -1.7% 6.8% 8.3% 10.3%
US Mid Cap Growth 3.2% 5.4% 18.5% 10.7% 13.4%
by 3.4%. Although U.S. equity valuations are off their highs, international stocks US Mid Cap Value 2.4% -0.2% 7.6% 8.8% 11.3%
US Small Cap Growth 7.2% 9.7% 21.9% 10.6% 13.6%
are earlier in their economic cycles, with more attractive valuations. Thus, we US Small Cap Value 8.3% 5.4% 13.1% 11.2% 11.2%
continue to overweight international equities relative to our base case. International Developed -1.2% -2.7% 6.8% 4.9% 6.4%
(US Dollar)
International Small/Mid Cap Developed -1.6% -1.3% 12.4% 10.1% 11.3%
(US Dollar)
Emerging Market (US Dollar) -8.0% -6.7% 8.2% 5.6% 5.0%
Source: Bloomberg, Morningstar
Eurozone Equities Face Headwinds
Year-to-date, Eurozone stocks have ex- economic growth rates now falling be-
Chart 4 : Euro area economic surprise index
perienced a risk-off environment after low peak rates, the region’s economy
a superb 2017. Last year brought eco- is still expanding. We believe the Euro-
nomic data that repeatedly surpassed zone’s recent equity weakness is tem-
expectations. However, these “beats” porary and the trend will reverse, re-
80
were unsustainable, leading to a rever- turning equities to a positive trajectory
sal this year, as shown in the economic over the short-to-medium term. As we
surprise index (Chart 4). Furthermore, have noted before, the region’s recov- 0
the recent formation of a populist Ital- ery from the 2012 sovereign debt crisis
ian government has driven fears that It- largely mirrors the United States’ recov-
aly could withdraw from the European ery from recession in 2008. Housing, -80
Union, creating a Brexit-like event. This unemployment, GDP, and other indica- BOTTOMING
raises concerns over how the new gov- tors have all improved at similar rates, -160 MRB Partners Inc © 06/2018
ernment will choose to grow its econo- but with a three-to-four year lag to the
my. Finally, trade tensions with the U.S. U.S. Further, the region has a support- 2004 2006 2008 2010 2012 2014 2016 2018
have placed negative pressure on auto ive monetary policy, earnings growth Source: Citigroup
and industrial stocks in Europe. Despite expectations continue to increase, and
the negative news flow and current valuations remain relatively attractive.
Market Point Second Quarter 2018
What’s Wrong with Financials?
Chart 5 : Financial stocks are lagging year-to-date
The global financial sector—bank short (in the form of interest paid on Global Stock Prices *: Financials / Broad Market (LS)
stocks in particular—has underper- deposits). Increasing inflation expecta- U.S. 10-Year Treasury Yield (%,RS)
formed in 2018 (Chart 5). In the U.S., the tions and a better outlook for long-term
yield curve has flattened due to lower economic growth could push the long 2.8
100
growth expectations (reflected in the end of the curve higher, benefiting the
long end of the curve), while the Fed- financial sector. We have had a tactical 2.4
96
eral Reserve has continued to increase overweight to financials for some time,
interest rates (reflected in the short-end and we continue to have conviction in 2.0
92
of the curve). In the Eurozone, the esca- that call. The Trump administration’s
lation of the Italian political situation, favorable view on loosening bank reg- 1.6
88
discussed above, triggered a signifi- ulations, and the result of recent stress
MRB Partners Inc © 06/2018
cant de-rating of financial stocks that tests in the U.S., also support the idea
2013 2014 2015 2016 2017 2018
caused the sector to underperform. that bank health has improved con-
Yield-curve flattening is generally bad siderably in the last 10 years. Interna-
* Relative to global equity benchmark; rebased: source: MSCI
for banks, which turn a profit by lend- tionally, a still-expanding Eurozone
ing long (in the form of mortgages and economy and very favorable valuations
other personal loans), and borrowing are bullish indicators for financials.
Small Caps Show Leadership
Chart 6 : Small-cap stocks have been strong
Despite volatility in the Eurozone and exchange rates make prices for their 144.5 Russell 2000 / 1000 Ratio Chart Range (years): 1, 2, 3, 5, 10, 20, Max
143.7
in the financial sector, one of the bright goods and services less competitive—a 142.9 Russell 2000 / 1000 (06/26/2018): 142.6
spots in Trust Point portfolios in recent relative boon for small-cap stock pric- 142.1 50-Day SMA (06/26/2018): 139.0
141.3
200 Day SMA (06/26/2018): 135.5
weeks has come from exposure to U.S. es. Finally, recent global trade tensions 140.4
139.6
small-cap stocks. Small-cap equities, between the U.S. and other regions— 138.8
those with market values of approxi- including China, Canada, Mexico, and 138.0
137.2
mately $1 billion to $10 billion, have Europe—have insulated small-cap 136.5
135.7
benefited (Chart 6) from several factors. companies that participate less in glob- 134.9
For one thing, as U.S. corporate tax rates al trade. Much more of small-cap com- 134.1
133.4
declined this year, smaller companies panies’ revenues come from inside the 132.6
131.8
have seen a greater positive impact U.S. (~21% overseas) compared to larg- 131.1
to their earnings than their large-cap er, multinational companies, which get 130.3
129.6
counterparts. Additionally, a stronger almost a third of their revenue (~30%
24 03 13 24 02 11 22 31 12 21 02 11 20 31 09 20 30 11 20 02 11 23 01 12 22 05 14 23 04 13 24 03 14 23 04 13 22
dollar hurts multinational companies overseas) from international markets. Jul ‘17 Aug ‘17 Sep ‘17 Oct ‘17 Nov ‘17 Dec ‘17 Jan ‘18 Feb ‘18 Mar ‘18 Apr ‘18 May ‘18 Jun ‘18
more than small-caps, since higher Source: Russell
Copyright 2018 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.
See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.
Market Point Second Quarter 2018
A Fixed Income Market
US Yields (%) Quarter-End 3 Mths Ago 1 Year Ago 3 Years Ago 5 Years Ago
Update from Trust Point
3 Month T-Bill 1.9% 1.7% 1.0% 0.0% 0.0%
2 Yr US Treasury 2.5% 2.3% 1.4% 0.6% 0.4%
10 Yr US Treasury 2.9% 2.7% 2.3% 2.4% 2.5%
Fixed Income Returns (%) 3 Month YTD 1 Year 3 Year (Ann) 5 Year (Ann)
Higher inflation and low unemployment rates allowed the Federal Reserve
US Intermediate Treasuries -1.0% -1.6% -1.5% 1.0% 1.7%
to hike the fed-funds target rate for the seventh time in June. Rising inter-
US Treasury Inflation Protected Sec. 0.8% 0.0% 2.1% 1.9% 1.7%
est rates have remained the key long-term risk to U.S. bond investors, as the US Mortgages 0.2% -1.0% 0.1% 1.5% 2.3%
US Short-Intermediate T/E Munis 0.8% 0.3% 0.2% 1.6% 2.0%
market adjusts to a less accommodative monetary policy. US Investment Grade Corporates -1.0% -3.3% -0.8% 3.1% 3.5%
US Senior Bank Loans 0.7% 2.2% 4.4% 4.2% 4.0%
US High Yield 1.0% 0.1% 2.5% 5.5% 5.5%
US Convertibles 3.8% 6.3% 12.0% 7.7% 10.0%
Int’l Bonds Ex-US (Hedged) 0.3% 1.7% 3.6% 4.0% 4.4%
Int’l Bonds (Unhedged) -2.8% -1.5% 1.4% 2.6% 1.5%
Emerging Market Debt (US Dollar) -3.5% -5.2% -2.4% 4.3% 4.4%
Source: Bloomberg, Morningstar
Bond Market Reaches New Milestones
The U.S. bond market has continued and the structural shift now taking
to gain attention as the 10-year place is forcing the Fed to rethink Chart 7 : U.S. Treasury yields rose to highest level since 2011
treasury yield surpassed 3%, peaking monetary policy. As the market has
at 3.11% in May, the highest level priced in higher short-term interest 3.5000
10-YEAR U.S. TREASURY YIELD
since 2011 (Chart 7). One factor that rates and higher inflation, this has
has kept yields moving higher is the provided upward pressure on bond 3.0000
2.8437
path of interest-rate hikes set forth yields. As rates adjusted higher,
by the Federal Reserve. As inflation the bond market has become more
2.5000
has risen, investors have priced in the fairly priced today. However, as
fact that the Fed will continue to hike geopolitical risk rose toward the end
short-term rates in an effort to keep of the quarter (and trade tensions in 2.0000
inflation from moving significantly particular), the pace of rising yields
over the 2% Core PCE target. Core slowed. The likelihood of a pause in 1.5000
PCE, the Fed’s preferred measure of rising yields has increased; we would
inflation when setting policy rates, not be surprised if rates remain stable
2011 2012 2013 2014 2015 2016 2017 2018
shows that inflation has finally risen to or move lower over the short term,
Source : Bloomberg
the Fed’s target for the first time since but our longer-term view has not
2012 (Chart 8). As the chart shows, changed in that we expect rates to
the U.S. has been in a low-inflation continue to grind higher.
environment for nearly a decade,
Market Point Second Quarter 2018Rate Strategies Pilot Positioning
Chart 8 : Reaching the Fed’s target of 2%
We have continued to structure sensitivity, we chose to tactically invest
U.S. CORE PCE INFLATION * Annual
fixed-income portfolios with less in- in TIPS using CPI swaps instead of % Change
2.400000
terest-rate sensitivity than the overall actual treasury inflation-protected
market and our benchmarks. It is this securities. Our exposure has very 2.200000
positioning that has been the biggest little interest-rate risk, while getting 2.000000
driver of our outperformance over the the same benefit from rising inflation,
1.800000
past two years. Since interest rates which has materialized in the second
bottomed in the middle of 2016, the half of 2017 and the first half of 2018. 1.600000
fixed-income portion of our modeled A second contributor has been bank 1.400000
portfolios is up over 4%, while the loans, which have been a staple in
1.200000
U.S. Aggregate Bond Index has had portfolios for a few years now. This
a negative return. One of the con- exposure is designed to benefit from 1.000000
tributors to this outperformance has rising interest rates. The coupon is
1995-1999 2000-2004 2005-2009 2010-2014 2015-2019
been our differentiated exposure in tied to short-term rates; as rates have © BCA Research 2018
the treasury inflation-protected secu- risen, so have coupons, supporting the *Excludes food and energy. Dashed horizontal line denotes Fed target
rities market (TIPS). While most TIPS price while maintaining a healthy yield
exposure comes with high interest-rate advantage over treasuries.
Cautiously Optimistic
Chart 9 : High yield spreads remain near cycle lows
As mentioned in last quarter’s report, future returns from price appreciation Percent Default rate and spread to worst 30-yr. avg. Latest
we have focused more attention on has diminished. From a valuation 20% Recession
Default Rate
Spread to worst
3.8%
5.8%
2.3%
4.1%
corporate credit markets recently. standpoint, prices for corporate bonds
As the economic expansion has are close to historical highs, and risk 16%
continued, corporate credit has been a premiums have been low for quite
good place to allocate funds, and our some time (Chart 9). In addition, 12%
preference for it has added significant the Federal Reserve has become less
value in portfolios. We have been supportive of the economy, as the 8%
able to capture additional yield in Fed will likely continue hiking short-
credit markets while benefiting from term rates to prevent inflation from 4%
the recovery in the U.S. economy. significantly overshooting its target.
However, corporate health has started In short, we expect returns from credit
0%
to deteriorate, as labor costs and pro- markets to be lower going forward. We
1988 1992 1996 2000 2004 2008 2012 2016
duction costs have risen with inflation. are currently evaluating whether the
Although profit growth has been additional risk in credit markets is still Source: J.P. Morgan
sustained on the back of tax cuts and warranted, given the outlook for more
corporations’ ability to pass on rising modest returns going forward.
costs to consumers, the outlook for
Market Point Second Quarter 2018Market Point is a quarterly market commentary designed to provide
you with an overview of economic conditions, as well as equity and
fixed income market summaries for the quarter.
This commentary is offered by the Investment management team.
The individuals contributing to Market Point are Randy Van Rooyen,
CFA®, Yan Arsenault, CFA®, CAIA, Brandon Hellenbrand, CFA®, Steve
Brudos, and Ryan Bergan. Please feel free to contact any team mem-
ber with questions.
Pictured left to right: Randy Van Rooyen, Ryan Bergan, Yan Arsenault,
Steve Brudos and Brandon Hellenbrand.
The opinions herein are those of Trust Point Inc, are made as of the date of this material, and are subject to change without notice. Trust Point uses its best efforts to compile its data from
reliable sources, however, it does not warrant the accuracy, completeness or timeliness of any of the information provided. This publication is prepared for general information only.
This material does not constitute investment advice and is not intended as an endorsement of any specific investment. Investors should seek advice regarding the appropriateness of
investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. All
investing involves the risk of loss, including principal, a reduction in earnings, and the loss of future earnings. Past performance is no guarantee of future results. Individual client portfolio
performance and transactions therein can vary greatly based on factors including investment strategy, objective, limitations, risk tolerance, time horizon, asset composition, asset alloca-
tion and tax implications.
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