Market & Economic Update
By: Nicholas A. Boyer, Chief Investment Strategist
Despite all the negative headlines regarding rising interest rates, market volatility and tariffs, the second quarter of 2018 was characterized by sustained strength in the U.S. economy as leading growth indicators continue to trend higher and the Atlanta Federal Reserve revised the gross domestic product (GDP) estimate for 2Q18 to around 4%.
Globally, softer economic data from the rest of the world reflected lingering structural weakness in Europe, Japan and China. Investors responded accordingly, as the dispersion of equity market returns increased with the S&P 500 returning 3.4%, while U.S. small cap stocks (Russell 2000 Index) returned an outsized 7.8% on the back of a stronger U.S. dollar and proportionally larger benefits from tax reform.
Meanwhile, international equities lagged with MSCI EAFE returns declining -1.1% and emerging markets equities continued their descent back to reality following stellar 2017 performance with a -7.9% decline in the MSCI Emerging Market Index on the quarter. On the fixed income side, interest rates continued to rise and bond portfolios experienced further volatility as the yield on the U.S. 10-year Treasury note ended the quarter at 2.85%, up over 10 basis points from the end of the first quarter and over 40 bps from year-end 2017.
The U.S. Economy Has Entered a Super Cycle
The U.S. consumer remains the primary driver of the U.S. economy and still plays a pivotal role in the global economy. So it’s perhaps underappreciated that in the midst of what has been described as a “tortoise-like” economic expansion, U.S. household net worth has surged to record highs, along with measures of consumer confidence which also remain near historical highs. Much of the recent growth in the U.S. has been driven by fiscal policy including tax cuts, repatriation and increased capital spending. In fact, U.S. companies repatriated $296 billion in corporate profits in the first quarter of 2018, about 17.6% of the estimated total $1.7 trillion of un-repatriated corporate profits for U.S.-based companies.
Meanwhile, the National Federation of Independent Businesses’ (NFIB) recent survey shows small business owners remain very optimistic about the nation’s economy as the NFIB Small Business Optimism Index posted 107.2 for June, its sixth-highest figure in its history. Perhaps most importantly, while we disagree with many economists who have belabored the lack of productivity growth given the unreliability of traditional metrics in today’s economy, even by outdated standards, U.S. productivity is on track to increase +1.5% year-over-year. This, along with downward pressure on prices from the broader impact of technology and perhaps greater-than-anticipated slack in the U.S. labor market, have kept inflation largely constrained. In an environment of easy financial market conditions, low inflation, increasing productivity, falling unemployment and increasing government spending, U.S. economic growth should continue to accelerate well into 2019 and beyond.
Even a U.S.-China Trade War Will Not Stop the Super Cycle…
Pundits say the trade war has begun, with the U.S. implementing 25% tariffs on $34 billion worth of goods from China, while announcing the potential for another 10% tariff on $200 billion of Chinese goods. The tariffs currently in effect on Chinese imports include semi-conductor chips assembled in China, plastics, dairy equipment, motor vehicles, electrical equipment, oil and gas drilling platform parts, chemicals and lubricants, as well as tariffs on washing machines, solar panels, steel and aluminum.
In retaliation, Beijing has begun implementing retaliatory tariffs on 545 products, targeting goods produced in states that voted for Donald Trump in 2016 – products like soybean, beef, fish, fruits, vegetables, dairy products, bourbon, cotton, tobacco and motor vehicles. While the impact of these tariffs are significant at a microeconomic level for companies in those specific sectors, we would note the broader macroeconomic impact of the tariffs currently in effect will be modest. The larger swath of tariffs on Chinese goods won’t become effective until August 30, but even the worst-case impact of a broader trade war (one that extends beyond U.S.-China) on global GDP has been estimated by JP Morgan at 0.4% in the near term, with the potential for a roughly 1.4% impact over two years. While this would doubtless have a meaningful impact on global growth, it remains too early to tell whether policymakers will continue to escalate these trade skirmishes, how each individual country will fare or what the net impact on the U.S. economy specifically will be. Yet, even analyst estimates with the most significant adverse impact on the U.S. don’t add up to a recession – defined by the National Bureau of Economic Research (NBER) as two consecutive quarters of negative growth in GDP.
…Because Only the Fed Can Stop It
While minutes from the Federal Open Market Committee (FOMC) meeting in June show the Federal Reserve has become more concerned about global trade, among other macroeconomic risks, they clearly expect to proceed with gradual rate hikes given the current strength of the U.S. economy and outlook. While Fed officials are closely monitoring the flattening yield curve and discussed a broad range of views on the topic, there were no signs of concern that it will result in reducing the pace of rate hikes and there was even some indication the FOMC might begin to look at the spread between current and future expected Federal Funds Rate rather than the more traditional 2-10 year U.S. Treasury spread, a widely used metric in the bond market.
Additionally, there were no signs the Fed would look to slow down or stop the reduction of its balance sheet, which remains perhaps the most important factor with respect to future yield curve and bond market activity. Ultimately, an inverted yield curve remains the best predictor of a recession and in the current environment under Chairman Powell, it’s difficult to imagine a scenario in which the Fed pushes the U.S. into a recession by ignoring financial market conditions and continuing to hike without regard for the economic risks. Rather, we would expect the Fed to closely monitor financial market conditions and respond to economic data and believe it stands ready to respond to macroeconomic shocks with further action, including potentially ending its balance sheet roll-off, among other options.
Asset Prices Will Remain Volatile but Continue to Grind Higher
Given that global economic growth will likely remain asymmetric and cross-asset correlations should decrease over the near and intermediate term, we expect investors will continue to differentiate accordingly, increasing dispersion of returns among asset classes. Nevertheless, while we expect market volatility in both stocks and bonds will increase periodically throughout 2018 and note the clustering effect, we believe the strength of the U.S. economy will continue to drive the global economic recovery and should provide support for global risk assets going forward. We continue to view the U.S. as the most favorable investment environment in the world, and in view of the outlook for corporate earnings we remain positive on U.S. equities. However, we are committed to globally diversified equity portfolios and still see more attractive valuations in international and emerging markets. We are also mindful of risks to bond markets as interest rates continue to rise and will look to improve and maintain credit quality in our fixed income portfolios, but as always, we note that a diversified asset allocation remains the foundation for meeting long-term investment objectives. We will closely monitor developments in the economy and global trade in particular and encourage our clients to reach out at any time to discuss our strategy and individual circumstances in further detail.
1 “GDPNow.” Federal Reserve Bank of Atlanta, 2018, www.frbatlanta.org.
2 Bloomberg Market Monitor
3 U.S. Department of The Treasury, Daily Treasury Curve Rates, www.treasury.gov
4 “Household and Nonprofit Organizations; Net Worth, Level.” FRED Economic Data, Federal Reserve Bank of St. Louis, 2018, https://fred.stlouisfed.org.
5 Bloomberg Economic Releases: Bloomberg Consumer Comfort
6 Chief Investment Officer Magazine, Market Moves: Capital Spending Shows Robust Growth for a Change; July 5, 2018
7 Trennert, Jason D., Investment Strategy Report: 12 Facts About the Markets, Economy, & Policy You Might Not Know, Strategas Securities, June 25, 2018
8 Bloomberg Economic Releases: NFIB Small Business Optimism Index
9 Brynjolfsson, Erik and Rock, Daniel and Syverson, Chad, Artificial Intelligence and the Modern Productivity Paradox: A Clash of Expectations and Statistics; November 2017
10 Hyman, Ed, Weekly Economic Report, EvercoreISI, July 9, 2018
11 Lebovitz, David and Voigt, Tyler, “How much should we worry about tariffs?,” JP Morgan Asset Management, March 2, 2018
12 Franck, Thomas, “What a full out trade war would cost the global economy,” CNBC Economy, July 2, 2018, www.cnbc.com
13 “2018 FOMC Meetings.” Federal Open Market Committee, 2018, https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
14 Tseng, Jie-Jun and Li, Sai-Ping, Asset Returns and Volatility Clustering in Financial Time Series; April 2011
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The past few months have been busy for the RKL Wealth Management team, with new members coming on board, others taking on new roles and an internship program giving industry experience to a new generation. Please join us in welcoming and commending the following individuals:
- Deb Lander, CFP®, QKA, joined the firm as a Retirement Plan Advisor. With more than two decades of experience in retirement planning, Deb helps clients design retirement plans, manage product offerings and investments and execute related fiduciary duties and responsibilities. She holds an Associate’s Degree in Banking & Finance from Central Pennsylvania College. Deb resides in York.
- Amy Strouse, CPA, previously a Manager with the Tax Services Group of RKL LLP, has transferred into the same role at RKL Wealth Management. Applying her strong background in individual taxation with a focus on tax planning and compliance
for high-net-worth individuals, Strouse will coordinate the firm’s financial planning services and serve as a liaison to the Tax Services Group. She holds a B.S.B.A. in Accounting from the University of Pittsburgh and resides in Auburn, PA.
- Jeffrey Guindon has been promoted from Portfolio Manager to Senior Wealth Advisor. In his new role, Jeff works with clients to identify their unique financial needs and goals and designs a customized plan to achieve them. Before joining RKL Wealth Management in 2016, Jeff gained a decade of experience in the wealth management and health care industries. He holds a B.S. in Sociology from James Madison University and an M.B.A. Finance from York College of Pennsylvania. Jeff lives in Lancaster.
- Brayden Campbell joined the firm as a Wealth Advisor. He specializes in tailoring plans for clients at all stages in life to accomplish their unique financial objectives. Brayden brings four years of commercial real estate investment and capital markets experience and holds a B.S. in Business Administration from American University’s Kogod School of Business. He resides in Palmyra.
- Patrick Semanchik and James Palys are RKL WM’s newest Investment Analysts, providing client portfolio analysis, reporting, monitoring and research for the investment team. Patrick brings eight years of experience as a financial and credit analyst along with a B.S. in Financial Economics from Moravian College and an M.S. in Finance from Villanova. Patrick resides in Harrisburg. James earned his B.B.A. Finance from Wilkes University in 2018 and resides in Lancaster.
- Nicolas Delgiorno and Kelly Updegrave joined the firm as Operations Associates, responsible for coordinating RKL Wealth Management’s day-to-day processes, including new client onboarding, database management and supporting the firm’s growing Retirement Planning practice. Nico holds a B.S. in Business Administration and Management from Alvernia University and resides in Lancaster. Kelly earned her B.S. Business Management/Administration from Bloomsburg University and lives in Columbia.
- Four interns are spending the summer at RKL WM: Jakob Sandman, Nikolas Madonis, Tommy O’Neill and Anastassiya Sayenko. Learn more about the RKL WM intern experience in the below feature penned by Anastassiya.
Intern Spotlight: Anastassiya Sayenko
My name is Anastassiya Sayenko and I am one of RKL Wealth Management’s four summer interns. Born in Almaty, Kazakhstan, I dreamed about coming to the United States from a young age. In 2014, I became one of the finalists of the Future Leaders Exchange (FLEX) program sponsored by the U.S. Department of State. The program gave me an opportunity to spend my senior year attending a high school in Lancaster and living with a local host family. After my exchange year, I decided to continue pursuing my education in the United States. Currently, I am a senior at Elizabethtown College, majoring in international business with a concentration in finance and a minor in psychology. On campus, I have served as a Resident Assistant for the past several years and am involved in research through the Department of Business and the Social Enterprise Institute. My goal is to pursue a career in finance after graduation.
RKL Wealth Management’s internship is a 10-week program that allows the interns to gain a practical experience in the field. The program includes orientation, shadowing, mentorship and opportunities to work with both investments and advisory teams. At this stage of my internship, I am working with the advisory teams in Lancaster and Reading. As a part of that experience, I get to attend client meetings and assist senior wealth advisors. I will be spending the second part of my internship with the investments team in Lancaster. Some of my favorite aspects of the program so far have been the opportunities to learn directly from full-time members of the team by working on projects, as well as shadowing and mentorship opportunities which have allowed me to start developing meaningful professional relationships. I am looking forward to the second part of the program and as it comes closer to its end, I am hoping to narrow down my career interests and develop a better understanding of both wealth management and the financial services industry in general.
Uncover Tax Reform’s Personal Planning and Wealth Management Opportunities at RKL WM’s Tax Reform Seminar
The Tax Cuts and Jobs Act represents the most significant changes to the tax code in more than 30 years. Provisions like lower tax rates and changes to certain deductions have generated many headlines, but what do they mean for individuals? Get a comprehensive perspective from the RKL Wealth Management team, who will highlight key considerations and identify strategies for charitable giving, retirement planning and more. Don’t miss out on this opportunity to uncover the personal planning and wealth management benefits under tax reform – register today!
Tuesday, September 25, 2018 | 4:30 p.m.
Cocktail hour with heavy hors d’oeuvres begins at 4:30 p.m. | Seminar begins at 5:30 p.m. Dessert to follow.
Lancaster Country Club
1466 New Holland Pike | Lancaster, PA 17601
RSVP to Diane Loftus at 717.399.1637 or dloftus@RKLwealth.com by September 11, 2018.
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. The information and data contained herein was obtained from sources we believe to be reliable but it has not been independently verified. Past performance is no guarantee of future results. RKL Wealth Management LLC is a registered investment adviser. To learn more about how we can help you meet your goals, please contact our office at (717) 399-1700 or via our website, rklwealth.com. Additional information is available upon request. © 2018 RKL Wealth Management LLC – All rights reserved.