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Investment Outlook - Second Quarter 2018

Focus on the Fundamentals 

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By: Tyler Smith
Monday, July 16, 2018

It sure is easy to find something to dislike in the market these days. Whether it is the threat of an international trade war, rising interest rates, or general political tension, the bears certainly seem to have the ammunition on their side.  However, even with all of the negative headlines and the seemingly- “one step forward, two steps back”-type of environment, the major market averages were all able to grind out positive returns for the quarter.  
 
In times like these where it looks as if the country is having a bit of an identity crisis, it becomes ever more important to take a step back and focus on the fundamentals.  Nobody knows what the future holds or when the next market-moving headline might hit.  What we can look to are the underlying fundamentals currently supporting this economy.  When you remove all of the noise and consider these factors, we look to be in decent shape.  Unemployment is at historic lows, wages are rising, and inflation has yet to materialize in a meaningful way.
 
There is good chance that we have not seen the end of the volatility that has consumed the markets over the past several months.  Most would agree that we are moving towards the later stages of an economic cycle, and with that inevitably comes greater uncertainty.  What this ultimately means for stocks is a more pronounced divergence between the winners and the losers.  Said another way, we are gradually moving away from an environment where the rising tide has lifted all boats, to one more dependent upon the captains navigating their ships through more unpredictable waters.  Companies with good management teams, solid business models, and favorable outlooks will be rewarded, while those lacking in these areas will begin to see less sympathy from investors.  We remain committed to identifying those companies best suited to endure whatever the economy might throw their way with an eye toward achieving consistent, long-term results.
 
Looking at the market performance in the second quarter, the tech-heavy NASDAQ again led the way with just over a 6% gain.  The S&P500 and Dow Jones Industrial Average also ended the quarter in positive territory (up 3% and 1% respectively), rebounding from the declines earlier in the year.  Through the first six months of the year, the NASDAQ is up 8.7%, the S&P is up 2.6%, and the Dow is about flat.  
 
This dynamic is interesting.  Several of the large-cap technology companies have effectively assumed the role as the defensive investment options in the face of increased market volatility.  Historically, this role would have been filled by companies in the staples, healthcare, or utility sectors. This shift in preference suggests that investors are becoming more comfortable with the longer-term viability of select technology companies, while at the same time, starting to question the sustainability of some of the legacy defensive business models (more on this in our “Ask the Rational Investor” section of the Outlook).
 
To wrap things up, the Bloomberg Barclays Intermediate Government Credit Bond Index posted a slight gain in the quarter as rising short-term interest rates have not driven equal increases in the mid- and long-term sections of the yield curve (bond prices decline as interest rates rise). The index remains down about 1% year-to-date.
 

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