June 2018 Commentary

The Dow Jones Industrial Average (DOW) is back over 25,000 and is back to its normal ebb and flow after a very profitable, yet complacent 2017.  The broad stock market is up 2-4% (depending on the index being used) on a year-to-date basis through June 12, 2018 and volatility is now back to its normal range.  The S&P 500 Index’s price-to-earnings (P/E) ratio is now 16.6x down from 18.0x in January 2018.  Historically, the stock market has sold in the 12.0-18.0x range so it is now close to being back in the middle of the range rather than at the high end. So, with a P/E multiple at 16.6x and a strong corporate earnings outlook, I believe the stock market should continue to rise with earnings this year pushing the Dow over 26,400 and the S&P 500 Index over 2,900; implying an 8% stock market gain for 2018.  This estimate is based on the market discounting or “pricing-in” 2019 corporate earnings.

THE ECONOMY AND CORPORATE EARNINGS GROWTH.

As we are reading in the media, U.S. economic growth remains solid with business and consumer confidence at a 14-year high and businesses continue to hire new workers. The unemployment rate is currently 3.8% which is an 18 year low!  The Conference Board estimates US economic growth of 2.9% and 3.0% for 2018 and 2019, respectively.  Global economic growth is rising as well. The World Bank recently raised its Global economic growth estimate to 3.0% for 2018, up from its previous 2.9%.  S&P 500 corporate earnings are expected to rise 23% in 2018 and 9% in 2019.  The recently enacted corporate tax rate reduction contributes approximately 1/3 of the earnings growth in 2018.  I believe the stock market has already “priced-in” 2018 earnings, and any stock market gains in 2018 should reflect the markets’ confidence in the 2019 9% earnings growth being realized. 

TRADE AND GEOPOLITICAL ISSUES

Trade tensions remain an issue and causing uncertainty in the business community.  The Trump Administration continues to push forward to have our major trading partners remove trade barriers to reduce our $600 billion trade deficit. The U.S. has a $400 Billion trade deficit with China.  Did you know??  If a car manufactured in the U.S. is sold in China, a 25% tariff is imposed, and if a car manufactured in China and ships to the U.S., only a 2.5% tariff is imposed.  All apparel imports into China were assessed a 22% tariff, which is now being reduced to 10%. Even ice cream is assessed a 30% tariff!   If a U.S. manufacturer wants to bypass Chinese tariffs, they can build a factory in China.  However, in doing so, the U.S. company investing in the Chinese factory is required to forfeit 51% ownership and transfer its technology to China.  Many companies have acquiesced to these policies to gain a cost advantage and access to the Chinese market. Now let’s “Follow The Money”……  Each year China receives $400 billion of U.S. currency which it can use in several ways.  China has purchased billions of dollars of U.S Treasuries and, in essence, has helped fund our federal deficit.  Our politicians benefit because they can spend the funds and provide “goodies” to their constituents to get re-elected and maintain their power.  The result is that our children and grandchildren will be saddled with high debt and will be taxed at higher rates than would be the case if our Federal government did not run secular deficits.  China is also purchasing companies and real estate here in the U.S. Plain and simple, the trade deficit is a wealth transfer to China!

CONCERNS…WHAT COULD GO WRONG?

All eyes are on The Federal Reserve Board (FED) and interest rates.  Will the FED make a monetary policy mistake? Or will it be able to reduce its balance sheet and increase interest rates without damaging consumer demand and business investment?  The FED, with a $4 trillion balance sheet, is in uncharted territory after many years of implementing an “easy money” policy and infusing substantial liquidity into the financial system.  Time will tell how it will do, but I believe this is an important risk about which investors should be aware.

The U.S. Deficit is swelling again and is expected to be $800 billion to $1 trillion in 2018.  Congress recently passed, and the President signed (after a veto threat), a $1.3 trillion Omnibus Spending Bill that will keep the Government running through September 2018.  This budget, along with “non-discretionary- entitlements” spending, will push annual spending well over $4 trillion for 2018.   This is risky and irresponsible, in my opinion, when unemployment is at 3.8%! 

THIS IS THE PERFECT TIME TO REVIEW INVESTMENT STRATEGY AND AFFIRM PORTFOLIO POSITIONS.

 An investment portfolio’s allocation to stocks, real estate, commodities, bonds, and cash determines more than 90% of a portfolio’s potential return and risk.  We added “long short” funds to many client portfolios during the past two years to add to client portfolios equity investments with a measure of downside protection.  These funds have managed to capture much of the markets’ upside return while having approximately half the volatility or risk of the market.

Thank you … And as always … “FOLLOW THE MONEY”

Rich Lawrence, CFA

Disclosure:

This market update includes data we believe to be accurate. However, Lawrence Wealth Management (LWM) does not warrant or guarantee its accuracy.  Opinions about the future are not predictions, guarantees or forecasts. Investing in stock and bond markets have risk that could lead to investors losing money. 

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