The second quarter of 2018 began in April with early warning shots of what now looks to be a fully active trade war. The US has imposed tariffs on a range of goods not just from China, but also from some of the US’s most stalwart trading partners in Europe and North America. Investors are reading the initial impact to weigh considerably more on foreign markets than on those in the US. Indeed, the US fared far better in the second quarter than did the rest of the world. The US-based S&P 500 was up 3.4% for the quarter and 2.6% year-to-date, while stocks in both developed and emerging markets outside the US have been in negative territory since the beginning of 2018. The overall global MSCI All Country World Index was roughly flat for the quarter and since the beginning of the year – but exclude the US, and there’s a marked difference between the US and the rest of the world.
It’s hard to predict the extent of the trade battles and the impact they will have. Major economists debate the effects on growth, industry dynamics and inflation, but most agree the impact will put at least a damper on the current strong economic conditions in the US and elsewhere. In addition, US stocks already looked expensive compared with those of other markets, and now even more so. If trade actions are contained, valuations outside the US now look quite attractive, particularly on a relative basis.
Bonds continued their sluggish performance for the year, as inflation expectations have generally been driving interest rates higher and bond prices lower. That effect moderated a bit this quarter. The broad-based Bloomberg Barclays Aggregate Bond Index was roughly flat, and -1.6% year-to-date. The Federal Reserve continued its response to positive economic conditions by raising the federal funds rate by 0.25% in June as expected, to a range of 1.75% to 2.0%. However, longer rates stayed steady leading to a flattening yield curve that signals a weakening future outlook among investors.
Oil prices are up but we see this as a temporary, geopolitically-driven phenomenon as the world moves past its reliance on fossil fuels. This quarter brought encouraging news on climate action that may have gotten lost among more sensational headlines:
No doubt, things are changing and in ways once unimaginable. One stark example is the downfall of industrial conglomerate General Electric. Founded 126 years ago by Thomas Edison among others, GE rose to become one of the country’s best-known and most admired companies, albeit one of its largest polluters. But in the early 2000s, GE significantly overextended its finance operations, leading to big struggles through the recession from which the company was never able to fully recover. Since early 2017, an already-lagging GE lost more than half of its market value. Last month, GE’s struggles culminated in its expulsion from the Dow Jones Industrial Index. The story of GE is indeed a story of the downfall of an icon, confirming the adage that change is the only constant. In the context of battling climate change and moving beyond fossil fuel-dependence, GE’s cautionary tale may actually signal hope.