Decisions, Decisions

Summer is here!  That means things are winding down in the world of sports as the Washington Capitals took home Lord Stanley’s Cup, the Golden State Warriors breezed through the NBA Finals and Justify became only the second undefeated Triple Crown winner.  Now, only diehard baseball fans are left with anything to watch, unless of course you can follow the World Cup despite team USA embarrassingly failing to qualify because they could not beat Trinidad and Tobago…yes, Trinidad and Tobago!  In the meantime, all eyes will turn to LeBron James as he chooses where to potentially finish his career, “The Decision: Part III.“

After 15 years in the NBA, the best player of all-time (sorry Jordan fans!) is coming off arguably the best season of his career but he still failed to challenge the mighty Warriors due to a weak supporting cast and of course J.R. Smith’s boneheaded play in Game 1.  Now a free agent, LeBron has no shortage of suitors this summer.  Vegas gives the Lakers the best odds to land the superstar, followed closely by the Cavaliers, Sixers and Rockets in some order.  So will the G.O.A.T. bring Showtime back to LA?  Does he remain with his hometown team in Cleveland?  Or maybe he pulls a stunner and goes somewhere unexpected?  Who knows!

Just as LeBron is weighing his future options, investors are also trying to digest all of the recent economic data and geopolitical events to determine the future for financial markets.

Markets were underwhelming in the first half of 2018 despite numerous perceived tailwinds.  First quarter earnings for S&P 500 companies grew by 24% and revenues jumped 11%.  Tax cuts boosted disposable incomes and drove consumer spending to the point where GDP growth may reach 4% for the second quarter.  The labor market continues to be extremely strong with the unemployment rate sitting at an 18-year low.  So with all of this hype and apparent strength in the U.S. economy, why haven’t markets been able to build upon their 2017 momentum?

Well, like LeBron’s Cavs, weak supporting data elsewhere in the world introduced uncertainty and stalled market momentum.  Things have become a bit murky internationally due to escalating geopolitical tensions.  The U.S. and its top trading partners are in the middle of a high-stakes game of chicken over tariffs that could potentially spark a trade war.  Questions still remain about North Korea and whether the recent summit with the U.S. will bring stability to the region.  In the Eurozone, softer economic data and higher rates point to slower growth, not to mention anti-establishment pressures in parts of the European Union are only adding complexity to the situation.

So what does the future hold for markets? Where are they headed for the second half of 2018 and beyond?

It is no secret that investors are becoming wary of rising rates.  The Federal Reserve is now forecasting five additional interest rate hikes by the end of 2019 and the European Central Bank announced that they will end their bond-buying program by year-end.  Despite conventional wisdom suggesting that higher interest rates result in poor stock performance, history suggests that is not necessarily the case.  The yield on the 10-Year U.S. Treasury is currently hovering around the psychological threshold of 3%, but history shows that yields usually have to rise above 4%, even 5% before stock prices are negatively impacted.

Another worry for investors is that inflation appears to be firming with the potential to accelerate due to the inflationary impact tariffs tend to have by driving up prices.  While the economy is warm, it is not overheating just yet.  Inflation data remains near the Fed’s target of 2% and annualized wage growth sits at a moderate 2.7%, well below the 4% level that has historically coincided with market downturns and recessions. 

With all this being said, equity bull markets rarely come to an end without a recession and the probability for one over the next year is still extremely low.  The current economic expansion should continue given the business cycle is in its mid-to-late stages, but monetary policy will be more restrictive moving forward.  If geopolitical risks can fade, then the strong fundamentals supporting financial markets should prevail and be able to push them higher over the second half, even if some volatility persists.  So like LeBron’s decision, let’s hope that these current uncertainties work out for the best and lead to one last great stretch run. 
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