Q3 2018 Economic / Market Recap
The 3rd Quarter finished with strong economic and market conditions in the U.S. International financial markets and the US Bond Market, however, continued to face headwinds that have been persistent for the bulk of 2018. Through the 3rd Quarter, the S&P 500 index is up for the year.i The rest of the world’s stock markets, however, have not fared so well and have lost 3.0% this year through the 3rd Quarter.ii The US Bond Market has struggled throughout 2018 and is down 1.6% through the 3rd Quarter.iii
The first two weeks of the 4th Quarter are off to an exciting start as both the stock and the bond markets are down sharply. A couple of easy culprits to point to are rising interest rates, profit taking and the upcoming mid-term elections. At this point, non-US stock markets are generally close to a technical Bear Market while the US stock market is close to a correction.
Q4 & Rest of 2018 Outlook
Washington, DC Updated & Mid-Term Elections Impact
It would be fair to state that no matter what your political perspective is that Washington, DC is a massive train wreck. Gone is the ability of the Republicans and the Democrats to compromise on absolutely anything. In the place of bipartisan policies are instances of invoking aggressive tactics against the opposite party, Jerry Springer-like disagreements over Supreme Court nominations and party line voting for virtually everything.
This dysfunction will manifest itself during the mid-term elections on November 6th. Currently, most political polls favor the Democrats with a slight edge to regaining the House of Representative from the Republicans.iv Personally, we think the polls aren’t as close as they appear, and the Republicans will keep the House—we shall see.
The Senate is a little different as only a handful of Republicans are up for reelection. It appears that the Republicans will retain control.v
The real question, of course, is how does the election outcome affect the economy and the financial markets? Should the Democrats win the House, but Republicans maintain the Senate it would be the identical political situation after the 2010 mid-term elections. In this scenario, we would expect nothing more than gridlock.
Should the Republicans maintain the House and Senate, we would expect them to consider their victory as confirmation from the American public that their actions over the last two years (i.e., tax cuts, tariffs, conservative Supreme Court justices, etc.) were viewed in a positive light. We would expect that Republicans would attempt to push further on some of their stated goals (i.e., immigration and healthcare reform). We would also expect the extremely toxic environment to continue.
We have had several clients ask what happens if the Democrats regain the House, would they impeach President Trump? Obviously, we are not political pundits, but based upon the political climate it would appear that almost anything is possible. However, we would suggest that even if President Trump is impeached that it would be extremely unlikely that the Democrats would have the necessary votes in the Senate to remove him from office. Instead, what is likely is that it will be a national embarrassment and that markets will react negatively. We do not have many cases to reference (i.e., Andrew Johnson, Richard Nixon-resigned, Bill Clinton), but in the cases of both Nixon and Clinton markets experienced turmoil in both cases.vi vii
There have been 18 mid-term elections since 1946. The good news is that in every instance from 1946-2014, the S&P 500 posted a positive gain in the calendar year that followed the mid-term election.viii It would not surprise us, with the pressure of the mid-terms removed, to see a year-end market rally this year. Whatever the results of these mid-term elections are it will likely only set the stage for an even bigger battle in 2020.
US Economic Production
While Washington, DC may be a train wreck, the U.S. economy is moving at speeds not seen in a long while. The Atlanta Federal Reserve is projecting 3rd Quarter U.S. GDP to be at an annualized rate of 4.2%.ix As a reminder, 2nd Quarter U.S. GDP was also 4.2%.x If the 4th Quarter continues at a similar pace, the U.S. economy will have grown at its faster pace over the course of a year since 2005.xi
At this point, there is little evidence that suggests that a significant slowdown is in the immediate future for the U.S. economy. Unemployment has fallen to a multi-decade low of 3.7%.xii Wage growth has increased steadily over the last 9 months.xiii Said plainly, people have jobs and their incomes are increasing. These two factors are not typically signs of a slowing economy.
In addition, the Federal Reserve is in the process of increasing interest rates. Again, not typically what is done when there is the potential of a slowdown on the horizon. On the contrary, the Federal it appears is in the process of trying to keep the economy from overheating.
Finally, although not terribly scientific, almost every business-owner that we have spoken with over the last 12 months has expressed their excitement over their business as well as their optimism of continued growth.
It would appear that most Americans feel good about their current economic situation. Why wouldn’t they? They have jobs. They are getting pay increases. They are buying homes. Their investment accounts have mostly grown over the last couple of years.
Federal Reserve Actions & Interest Rate Movement
The Federal Reserve started increasing rates in late 2015. The Federal Reserve, neither the President nor Congress, is most responsible for the day-to-day function of the US economy. Their primary weapon to combat recessions, inflation, a struggling or an overheated economy is the adjustment of interest rates.
Remembering back to 2015, short-term interest rates, mortgage rates, CDs rates, etc. were near all-time lows. The issue facing the Federal Reserve at that time was if the economy unexpectedly suffered a slowdown there was little that they could do to support the economy. Fast forward to today and the Federal Reserve has steadily replenished its war chest.
How can that be a problem? The slippery slope that the Federal Reserve consistently walks is keeping interest rates at a level to stimulate growth, but not allowing the economy to get too hot. Historically, what tends to happen is interest rates eventually reach an equilibrium point. At this point, short-term interest rates and long-term interest become essentially the same and short-term interest rates may even temporarily become higher (called an inverted yield curve). This is generally signaling a recession in the economy.
Depending upon the continued pace of Federal Reserve increases over the next 12 months or so, the equilibrium point could occur late in 2019 or early 2020. Perhaps this is why President Trump recently called Federal Reserve Chair Jerome Powell “loco”.xiv President Trump absolutely does not want the economy to begin to slowdown in 2020—you can guess why!
Just as there always is, the amount of negative news presented by the mainstream media is overwhelming. Even good news, such as economic growth, can garner a negative response. For instance, the New York Times wrote in July an article discussing the 2nd Quarter’s GDP titled, “Why Friday’s G.D.P. Number May Be a Size Too Big”.xv We would encourage our clients to try to disconnect a bit from the mainstream media or at a minimum take it with some degree of perspective. Make no mistake there is an agenda in their reporting and it does not necessarily have your best interest in mind.
Instead, we would encourage continuing to focus on actual data and their own personal set of goals and objectives. If your goals and objectives are being maintained and accomplished that is really all that should matter. This is something that we are also here to help with. We spend countless hours monitoring, analyzing and adjusting, when appropriate, investment accounts in an attempt to assist clients in accomplishing their goals.
Try not to be overly concerned when markets go through a tough week or month. Generally speaking, volatility is normal and healthy. Try not to worry too much about who wins the election. Markets have gone up during times that Democrats controlled Washington just as markets have gone up during times that Republicans controlled Washington. As we have laid out above, both the US economy and financial markets are currently showing little signs of a major breakdown in the short term. We do not see the outcome of the mid-term elections, whatever they may be, having a dramatic impact upon markets over the short term.
On another note, we would like to introduce our newest staff member, Adam Higgins. Adam is Rick’s son. He graduated from The Citadel in 2017. He has spent the last year as a financial advisor at AXA Financial in Greenville. Adam will be handling service and marketing in our insurance department before starting a transition to a financial advisor sometime in 2019. Please help us welcome Adam to the team!
As always, should you have any questions, please do not hesitate to let us know. We are here to discuss your goals and objectives as well as discuss economic/market/financial issues that may be keeping you up at night.
Thank you for your continued confidence and business! We look forward to talking with you soon.
vi Isbitts, Rob. “Watergate and The Stock Market: A Brief Review”. May 23, 2017.
vii Steward, Emily. “When Clinton Was Impeached, Markets Gained; With Trump, It Might Be Different”. May 21, 2017.
viii “How Stocks Have Fared Following Midterm Elections.” First Trust. www.ftportfolios.com. October 4, 2018.
xi Miller, Rich & Chandra, Sho. “US Heads for Best Growth Since 2005 on Robust Domestic Demand”. www.bloomberg.com. August 21, 2018.
xv Casselman, Ben. “Why Friday’s G.D.P. Number May Be a Size Too Big”. www.nytimes.com. July 26, 2018.