Q1 2018 Market Commentary
David Y. Sun, CFA®

The new year started on a bullish note only to be interrupted by a January wage growth report that exceeded expectations. This was interpreted as the beginning of a long awaited upward trend in inflation, causing equity markets to come off recent highs whi le bonds continued to sell off due to the anticipation of higher interest rates. Even though the February wage growth report fell short of expectations, the Fed followed through on raising rates in March which kept equity markets in check. After the Fed’s decision, the question on everyone’s mind was, “How many more increases remain for 2018?” With the understanding that current signs of inflation may not be demand driven, our focus is not on the number of remaining increases but on the evidence supporting the increases.

-We believe that inflation indicators are being influenced by variables such as the weaker U.S. Dollar and higher oil prices. Such non-demand driven inflation factors, that cannot be supported by existing economic conditions, can potentially have a negative impact on GDP growth. In this scenario, the need for raising rates may not be necessary despite inflationary signs. If rates are raised by the Fed, there is the possibility of an accelerated slowdown in our economy. This is evidenced by recent whispers on the street of another recession. We will avoid such extremes at this time when commenting on our outlook for the U.S economy. Instead, we will continue to closely monitor wage growth and GDP reports to see if inflation is sustainable or a drag on GDP growth.

During the latter part of the first quarter, equity markets continued to soften but the volatility increased when the current administration blindsided Wall Street with tariff announcements on steel and aluminum. As investors awaited further clarification on these statements, additional tariff announcements were made targeting Chinese imports, which resulted in China’s retaliatory announcement of tariffs on U.S. products. The fear of global trade wars gripped equity markets around the world and caused the DJIA to test our fundamental support level of 23,400.

Prior to the initial salvos of a possible trade war between the U.S. and China, signs of inflation were already creeping into earnings reports in the form of rising labor, transportation and material costs. Even though many companies within various industries will benefit from Tax Reform, pressure on margins is a real issue moving forward. Due to higher costs, we are noticing signs of negative adjustments to projected earnings. The ability to pass on such costs to consumers will be a factor in determining if inflation is sustainable.

We must also note; tit-for-tat retaliatory tariffs can be a double-edged sword in its impact on Capital Market Expectations. The higher cost of imported goods due to tariffs could be an additional catalyst to domestic inflation. On the other hand, tariffs on exported goods can apply downward pressure on sales growth which results in several factors threatening global economic growth. These reasons are often the basis for the belief that trade wars never benefit either side.

As long-term investors, our portfolio decisions will always be driven by fundamentals. We also acknowledge that short-term volatility is not only unnerving on a psychological level but can have a negative impact on portfolios that are exposed to “Sequence Risk” due to established spending rates. The need to liquidate positions to subsidize withdrawals in a volatile/down market can put pressure on portfolios for the long-run but such risk can be managed through decisions involving asset allocation, cash positions and defensive equities (value/dividend yielding).

Should you have any questions regarding your portfolio or the recent market volatility, please contact your consultant. We truly appreciate your patience and confidence as we navigate through these challenging conditions.

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