Quartery Market Report: 2Q 2018
Second Quarter 2018 has come and gone with a little bit of choppiness in the markets. Some parts did better than others: U.S. and Emerging Markets stocks both reversed their movements from last quarter, with U.S. stocks bouncing back and Emerging Markets seeing some depreciation. This is a textbook case for why we invest in all parts of the stock market. However, even with the volatility that we did experience this quarter, the market movements weren’t great enough to trigger our rebalancing process. (See Pages 5, 6 and 7 for the details.)
As you know, your portfolio “tilts” toward small company stocks, value company stocks and profitable company stocks. In 2nd Quarter, the tilt toward small company stocks helped in a major way, as small companies vastly outperformed larger ones. We know these tilts may not work every quarter, but over time, we expect them to add some additional return to your investments.
One interesting thing to note is that the U.S. dollar continued to strengthen in relation to pretty much every other currency in the world. (See Page 8.) As U.S. short-term interest rates rise, expect to see more international investors park their cash in higher-yielding, safer U.S. treasurys.
While a strong dollar sounds nice, it presents several problems moving forward. First, U.S. goods will become more expensive in other parts of the world, which will be a challenge for U.S. companies who have significant international sales. The flip-side to this is that foreign goods will become relatively less expensive here in the U.S. So don’t be surprised to see international companies do well. But of course the future is unpredictable, so we will stick with our strategy.
Also, a stronger dollar means that your money will go further in other countries. So if you’ve been thinking about traveling internationally, the time may be right.
Another interesting development is the increase in interest rates here in the U.S. and the “flattening” of the yield curve. (See Page 9.) A flattening yield curve means simply that the difference in yield between short-term treasury bonds and long-term treasury bonds has narrowed. In other words, longer-term treasury bond investors are not getting paid significantly more than short-term ones.
There are a few explanations for this. The first and most likely is that investors expect the Fed to raise interest rates in the future. The Fed has been pursuing a rising interest rate policy recently – and making it completely obvious to investors in an effort to not spook the markets. I would expect this to continue, since having interest rates a bit higher would benefit bond investors over the long term.
The next possible reason for a flattening yield curve would be an expectation that inflation will fall in the future. This could certainly happen, but given that inflation is currently low relative to historical levels, I don’t see that this would be likely in today’s environment. Remember, we do want some inflation over time, but deflation is a road we don’t want to go down.
The final reason that we may be seeing a flattening yield curve would be an expectation of slower economic growth. This is something that could certainly come into play, given our discussion with the strengthening dollar earlier. However, we may see more growth into 2019 as the TJCA tax reforms enacted this year start to play out.
Again, the future is unpredictable, so we will stick with our numbers-based strategy designed to avoid the things we know do not work over time.
At the end of this quarter’s report, I’ve included a commentary from Dimensional Fund Advisors (DFA), the mutual fund company that comprises our core investment holdings. The commentary is about having – and sticking to – an investment strategy designed for the long term. Just as in other parts of our lives, we often cannot control the events in which we find ourselves. However, our ability to control our reactions to those events can determine so much of our failures or successes.
As I read the article, I was reminded of the 2008 financial crisis. At the time, I worked at one of the large firms in Atlanta and had the privilege of working with some incredible clients. During that time when things seemed bleak, the best client reaction that I remember didn’t come from one of the high profile CEOs or big-name business owners. It came from a future hall-of-fame baseball player.
He was the epitome of the article’s point – controlling his reaction to events. He didn’t succumb to fear. Instead he said (to the best of my memory), “This is the kind of time when people with brass balls make tons of money. What do we need to do?” Being that cool under stress is one reason why his jersey has been retired.
And that’s how cool we will be when events happen that would knock normal investors out of their strategy.
Of course, I will continue to monitor the markets and make adjustments to your portfolio as needed. As you may remember, at Transformative Financial we use a numbers-based rebalancing process designed to “buy low and sell high”, little-by-little, over time.
Finally, I want to thank you for being along for the ride with me as I build this firm. July 1st was the first anniversary of Transformative Financial. It’s been an incredibly fun, challenging and rewarding journey and I’m thrilled that you’re on it with me.
Thank you for your continued trust.
Patrick King CFP®