Weekly market update
The major averages all finished May in positive territory and those who “sold in May and went away” should be very disappointed, especially if they sold their small caps which were on fire last month. The NASDAQ Composite just went out at an all-time monthly closing high. Should we ignore that? You think it’s something we historically find in uptrends? Or in downtrends? Our small-cap holding, the Alger Small Cap Focus fund (AOFAX) was up over 10.3% for May and is up almost 22% YTD. Once again, this is not something you see in downtrends.
These gains did not come without some volatility thanks to concerns over geopolitics, rising rates and a weakening global growth story.
Politics dominated the headlines in May, with the announcement of new governments in Italy and Spain. Why are Italy and Spain important? First—they have a political crisis, not a financial crisis, yet. But with their interest rates spiking like never before, they have to set aside more funds they would otherwise spend on things they want to spend and instead put it towards servicing their debt. And this affects the ECB as well which owns a lot of their bonds, which could have to be marked down. And they aren’t the only ones—European banks, large U.S. banks and money managers as well. And it is definitely going to impact the chance of the ECB raising rates any time soon and could perhaps impact our own central bank’s rate increases. Europe is like a trite horror movie that never ends. The one difference between the 2012 European Crisis and now—back then “whatever it takes” from the ECB was about to start, now it’s ending.
The implementation of steel and aluminum tariffs by the U.S. was put in place on some of our largest trading partners, including Canada, Mexico and the European Union. Initial reactions point to retaliation, but importantly, the magnitude of these tariffs remains minimal. While political developments have led to a spike in volatility, over the long term, markets are driven by fundamentals. The key for investors is to separate the signal from the noise—one cannot ignore political developments, but with global economic growth looking fairly solid (see below) and profits continuing to rise, we maintain our view that the path of least resistance for risk assets remains higher and believe that investors should position accordingly.
With regards to interest rates—the last several months have been challenging for fixed income investors as interest rates have been on the rise. Despite concerns surrounding the asset class, investors should not abandon the allocation to bonds in their overall portfolio. History has shown that bonds preserve wealth much better than other asset classes such as stocks and that, over the long run, fixed income investors are rewarded. Maintaining exposure to multiple sectors within fixed income can help to reduce the risk associated with owning bonds in rising rate environments and could even result in achieving positive returns over those time periods.
About that global synchronized growth story—it may be in jeopardy. Stocks rode the accelerating growth story to fresh records in early 2018, but are now hamstrung by a moderate but unmistakable slowdown in economic momentum in Europe and elsewhere outside the U.S. This could prove to be troublesome for all of those calls recommending an overweight for International stocks and underweighting the U.S.
We really didn’t resolve any of the issues we had at the beginning of May, we only added a few others. With the concerns over a swoon in June, we will have to be on alert, although it hasn’t started out looking that way. The wall of worry seems higher today than at the market lows in early February—our antennas are up here, but we’re reluctant to position too defensively at this stage.
So coming into June we will be watching the political landscape with the summit between the U.S. and North Korea which could be a historical event, and hopes are of something good happening. In my opinion, not having the summit would be better than a failed summit.
We will also be keeping an eye on interest rates as it is widely expected the FED will raise rates at next week’s meeting. More importantly will be their comments on the economy and how many more rate hikes to expect in 2018.
We will also be watching the economic data, here at home, for any softening similar to what is being experienced throughout Europe. Jobs growth remains very solid, unemployment can’t get much lower and the regional FED reports from Richmond, Dallas, New York, Philly and Chicago are all tracking very strong, and that could bode for a blowout GDP number for Q2 2018. We do expect to see more weakening for European economics over the summer and that’s because the country basically goes on holiday the whole summer.
With all that, I urge you to stay tuned and we’ll keep you posted.
Todd Day, Portfolio Manager
Horizon Financial Services, LLC
June 5, 2018
