Market Data Bank

2Q 2018

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U.S. stocks in the second quarter of 2018 returned to their winning ways, with the Standard & Poor's 500 posting a +3.4% total return.

Stocks had posted a -0.8% loss in the first quarter of 2018, following a +6.6% gain in the fourth quarter of 2017, a +4.5% gain in the third quarter, a +3.1% gain in the second quarter and a +6.1% gain in the first quarter of 2017.

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Small companies were the clear winners. The economic expansion - 109-months old - has boosted investors' tolerance for risk.

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Foreign stocks tanked in the second quarter, as fears about a trade war heightened. U.S. consumers drive economies across the globe. Foreign countries generally are more dependent on exports than the U.S. and were first to see asset values decline due to rising concern about a trade-war.

Among U.S. stocks, small- and mid-sized publicly-held companies are presumed less exposed to exports than large-caps, propelling the smaller companies to outperform in 2018Q2.

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In the quarter ended June 30, 2018, crude oil's +15.1% total return followed an +8.5% first-quarter return, and +16% in 4Q2017, and double-digit gain in 3Q2017. But the performance of asset classes were otherwise fairly random compared to the previous three month period.

For example, Master Limited Partnerships, which are often correlated with energy shares, were the biggest losers in the first quarter. Real estate investment trusts, the other big winner in the second quarter, was the second-biggest loser a quarter ago.

Agricultural commodities were the worst performer as grain prices slumped on China's threats to curtail U.S. soybean imports in the three-months ended June 30, 2018, but they were the second-best performer a quarter earlier.

Predicting next quarter's winning asset class amid domestic and foreign political, economic and financial risks is fraught. It's one of the way our firm is different from traditional Wall Street investment advice.

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For example, the world largest money manager, BlackRock's predicted in April 2016 that stocks would return less than 5% annually over the coming five years.

Twenty-seven months later, the call has been an investment disaster. An investor who followed BlackRock's advice would have missed out on a major leg in the 109-month bull market -- a run through June 30, 2018 of almost 30%.

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The Standard & Poor's 500 stock index opened the year strong, following the signing of the Tax Cuts And Jobs Act, soaring to a new all-time high at the end of January. However, psychology quickly changed in early February when fear of rising interest rates caused a correction of 10.2%.

In February, the U.S. Justice Department alleged a criminal conspiracy had been conducted by Russian agents to meddle in the 2016 U.S. presidential election, heightening U.S. political risk and President Trump began talking about tariff hikes, which sparked trade spats with U.S. allies and fears of a trade war with China. Despite the rising level of uncertainty, shares prices remained not far from their all-time.

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Stocks gained a very robust +14.4% over the 12 months ended June 30, 2018, despite February's -10% correction. Stocks had melted up in January 2018, on euphoria following the December 22, 2017 passage of the Tax Cut and Jobs Act. Vulnerable to bad news. Stocks sold off in February, after a stronger than expected January jobs report from the government fueled inflation jitters, along with increasing trade war talk from the White House.

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Consumer spending was booming in second quarter of 2018 and that fueled another sharp price rise in shares of consumer discretionary stocks.

It was the third consecutive quarter of strong returns in consumer discretionary stocks, which perform well in strong economic times like we've experienced in recent months.

Technology shares had their eighth straight quarter of gains, an impressive run. Not since 2Q2016 have tech industry share prices suffered a loss.

Energy companies benefited from rising oil prices and returned 13.5%, after suffering nearly a 6% loss in the first quarter.

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For the 12 months ended June 30, 2018, the technology sector was again a standout, as it was a year earlier.

The laggard sectors during the 12-month period - consumer staples, telecom and utilities - are considered more defensive and less volatile. With economic fundamentals strong, investors had an appetite for riskier growth stocks.

When you look back on performance of industry sectors, returns often seems logical and even predictable. But they're not.

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This chart illustrates the rotation in industry sector performance in the 12 months ended June 30, 2018, compared to the 12 months ended June 30, 2017.

The randomness of performance is stark. On June 30, 2017, after tech shares turned in by far the best performance over the previous 12 months, would you have wanted to bet that tech shares would continue to lead over the next 12 months ahead? If you are investing your retirement nest egg for the long haul, you are likely to be uncomfortable betting that last year's winner will repeat. Modern Portfolio Theory suggests periodic portfolio rebalancing.

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Modern portfolio theory is a large body of financial knowledge based on academic research done over the last 70 years.

This framework for investing is now taught in the world's best business schools and embraced by institutional investors.

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The world is too dynamic and not enough statistical history exists to make predictions with certainty. Modern Portfolio Theory is a framework for managing these risks based on financial, economic and statistical facts.

Classifying investments based on their distinct statistical characteristics imposes a quantitative discipline for managing assets based on history and fundamental facts about the economy.

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Of course, human judgment and an understanding of historical performance is critical in applying modern portfolio theory to an individual's portfolio. And this approach does not guarantee success - nothing can. It's called a theory because your investment results can't be guaranteed.

Applying portfolio theory requires periodically lightening up proportionately on the most-appreciated types of assets - small-cap value stocks - and buying more of the types of assets that lagged. The exact amount of each asset is set based on your personal preferences, age, and specific circumstances.

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For example, in the 12 months ended June 30, 2018, the Chinese stock market was the top of this list of regional foreign market indexes from across the globe, with a 20.6% return., while stocks in Europe lagged with a 6.7%. The outsized returns on China stocks would tilt your portfolio toward owning a larger amount of Chinese shares. If Chinese outperformance repeats, your portfolio would be more exposed to the risks that come with Chinese stocks. Meanwhile, the influence of European stocks would in your portfolio would be diminished.

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A key idea in managing a portfolio using modern analytics is rebalancing positions, selling off the most appreciated assets and purchasing more of the laggards.

European stocks were strong performers in the 12 months ended June 30, 2017, so rebalancing would have reduced your exposure to them when Europe was the weakest of the foreign markets in the 12 months ended June 30, 2018.

Rebalancing is an example of the quantitative strategic analysis driven by modern portfolio theory.

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Examining returns on U.S. stocks in the 12 months ended June 30, 2018 based on their key characteristics - valuation and market capitalization - riskier equities were favored.

Small-company and growth shares led the performance face, while stocks characterized as value investments and larger companies with more predictable results lagged.

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For the 12 months ended June 30, 2018 notably crude oil, commodities and U.S. stocks were the best performers among this broad array of 13 asset classes. The 60% gain in oil prices marked the third consecutive quarter in which oil was the leader among the asset classes. That's the happy side of this volatile sector, but it's wise to recall the downside risk of volatility.

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Crude oil lost nearly a quarter of its value in the 12-months ended September 30, 2016. Losses of that magnitude make it difficult to hold on for the long-term, to stay invested long enough to benefit from the long-term mean return of an investment, to stick around for oil's 60% return in the 12 months ended June 30, 2018.

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The excellent cumulative total return of 88% in the five-year period shown is an outgrowth of a nine-year economic expansion. It started in March 2009, when the U.S. economy emerged from the worst recession since The Great Depression of the 1930s.

In the 15 months from July 2013 to October 2014, the Standard & Poor's 500 rose steadily, until an abrupt 10% loss in October 2014. In what would become a pattern of this bull market cycle, the S&P 500 recovered in about three weeks. After trading sideways for 10 months, share prices in America's blue-chips hit another air pocket on August 24, 2015 in a five-minute "flash crash." Eleven percent of the value of America's largest publicly traded companies had evaporated in minutes. Months later, the cause was determined to have been a software-driven technical trading glitch, the same kind of program-trading that caused the 1987 stock market crash.

Prices quickly recovered in three months and prices went sideways until February 2016, when another double-digit loss struck stocks. Prices recovered within about three months yet again and then soared for two years. Tremendous gains came after the election of Donald J. Trump and buoyed throughout the legislative process of enacting a new federal tax law December 22, 2017. After hitting an all-time closing high in early February 2018, volatility returned. Two double digit corrections had struck in the first half of the year.

The likelihood of a bear market - a correction of at least 20% - increases as the bull market grows older. However, fundamental economic conditions that have accompanied bear markets in the past are not present as the end of July 2018 was approaching. Historically important precursors of a bear market downturn - restrictive Fed policy, signs of slowing growth, stock market overvaluation, and irrational exuberance - are still not evident.

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Riskier stocks - growth and smaller companies - led the performance race over the five years ended June 30, 2018.

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In the five years ended June 30, 2018, defensive industry sectors lagged. Returns on energy, telecom services, consumer staples, utilities, and materials -- sectors with relatively weak earnings growth, sharply lagged returns of industry sectors of the economy growing fastest. The technology sector, led by huge gains in Apple, Microsoft, Facebook and Google, was the leader.

Financials' strong five-year performance reflects a steady recovery from the wipeout they experienced in the 2008-09 global financial crisis. The energy and material sectors, of course, were slammed by the collapse in crude oil and most other commodity prices. The price of crude oil, while up dramatically from its early 2016 bottom of $26 per barrel, is still well below its peak 2014 price of $114 per barrel. The energy sector of the stock market is highly correlated with crude oil prices.

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America's 500 largest publicly-traded companies - a magnet for investors worldwide - outperformed all other major regional foreign stock markets by a substantial margin.

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It was a great five years for U.S. stocks! A dollar invested in American blue-chip shares grew to $1.88 - more than twice the return of foreign stock markets - in the five years ended June 30, 2018. U.S. stock market returns were explosive relative to this broad array of indexes representing 13 distinct asset classes.

In last place, was crude oil. Prices broke because of the surge in U.S. supply from improved shale-fracking techniques.

Meanwhile, if you ever watch commercials on financial cable TV for gold or other commodities investments, you may be interested in knowing that gold investments returned a big fat zero over the five years. The dollar was strong, inflation benign, and most commodities were in ample supply.

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Over the 10-year period ended June 30, 2018, the S&P 500 total return index gained +163%.

From the financial crisis share-price bottom on March 9, 2009, the S&P 500 total return index through June 2018 gained +389%.

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Signals of economic strength are about as strong as they ever get, but so is the background noise.

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President Trump talked face-to-face with the leader of North Korea and then declared the Asia nuclear crisis defused. U.S. and its allies traded mean tweets about trade in a spat after the annual G-7 summit. Meanwhile, the U.S. upped the ante in a separate trade skirmish with China and worries of a global slowdown heightened as tough trade talk grew louder. The first summit with Russia's Vladmir Putin, escalating tensions with Iran, amid domestic political events with little precedence in modern U.S. history, that was the news on the front pages for weeks.

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Meanwhile, amid all the distractions and headlines, a rabbit popped from a hat.

When U.S. history is written decades from now about the recent global political firestorm, the explosive growth in the U.S. economy - the bunny in the hat - may get more ink. It's deserved.

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Each of the red lines represent Wall Street analyst forecasts for earnings at America's 500 largest publicly-held companies for a calendar year, starting with the beginning of the current expansion cycle.

Unlike the first seven years shown, the earnings forecasts for 2018 and 2019 look totally different because earnings have surged anomalously.

Analysts started releasing earnings forecasts for 2011 in mid-2009, raising their expectations through mid-2011, before forecasts dropped off.

This pattern - of lowering earnings forecasts as the year draws near - is normal.

Year after year, analysts start out optimistically then lower their expectations as the end of the year draws closer.

However, the pattern through the first half of 2018 was totally different.

Earnings estimates surged and then continued to improve even as the end of 2018 drew closer.


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In the past month alone, earnings forecasts surged by 20%.

The 22% earnings growth rate expected for 2018 would be about three times the norm!


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Another strong signal is business optimism.

Small business employs half the private sector and was responsible for 70% of the new jobs created in the economic boom.

Through June, the small business optimism index hovered near its 45-year all-time high.


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June retail sales data showed consumers spending bigly. Excluding gasoline, because its volatile price distorts the data, retail sales grew 5.3% in the 12 months ended June 30. That compares to a 3.2% rate of growth achieved in the last 12 months of the last economic expansion in 2007. To be clear, retail sales are growing more than 60% faster than in the peak of the last expansion. Retail sales are a key indicator of economic strength because consumers account for 70% of U.S. economic growth.


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Sales at non-store retailers, including Amazon, soared 10.2% in the 12 months ended June 30, while sales at traditional retail department stores were flat. Food and drink places, a retail category where you normally do not see sudden accelerations in sales, surged recently.


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The forward looking index of 10 U.S. leading indicators of economic growth has been in record territory for many months and its surge resumed in June after flattening in May.


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The Atlanta Fed model signaled an astonishing 4.5% growth rate. The is a dynamic model of how fast the U.S. economy is growing, published by the Federal Reserve Bank of Atlanta.

The quarterly GDP growth model grows more accurate as the publication date of the data nears. With the GDP growth number for 2Q2018 just a week away, even if the actual figure comes in at 4%, it towers over the 2.2% quarterly growth average since the end of The Great Recession. Despite all of the distractions, setbacks and hurdles, key fundamentals of the economy remain incredibly strong.


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