Q3 2018 RECAP
October 3, 2018
3rd QUARTER 2018: BEST IN 5 YEARS FOR U.S. EQUITIES, THE S&P 500 UP 7%. OIL PRICES CLOSE AT 4-YR HIGHS. BOND YIELDS RISE, THE 10-YR ABOVE 3%. CENTRAL BANKS: FED HIKES, FUNDS RATE ABOVE 2%; ECB, BOJ STAND STILL. TRADE TARIFFS, FEARS OF ESCALATION WEIGHED ON INVESTOR SENTIMENT. U.S. DOLLAR WEIGHED ON EMERGING MARKETS JULY AND AUGUST, NOT SEPT.
The 2nd-half of 2018 opened on a strong note as economic data and corporate earnings lifted equity prices. An uninspiring 1st-half, marked by a market correction, along with trade concerns had left the S&P index with modest gains at midyear. Despite rolling and roiling headline news on tariffs, real and feared, investors focused on two fundamental pillars – the economy and earnings. Both beat expectations in Q3. Worth adding, the Dow Jones, long the laggard this year, outperformed in September, finally surpassing its January high. To a degree, this was a reflection of progress, albeit slow, beyond the headlines on trade. Multinationals recovered from declines as summer came to a close, and Nafta 2.0 was confirmed on the final day. Meanwhile, caution seeped into technology stocks as regulatory winds surfaced in Washington.
Global oil prices closed Q3 in a similar way to Q2, at a new 4-year high. The ongoing tussle between supply and demand was much more focused on the former. Despite an increase in production from OPEC and Russia to alleviate any potential shortage later this year stemming from Iranian sanctions, markets zeroed-in on reduced inventory levels and history. The increased amounts pledged by the aforementioned do not cover in full the possibility of removal of the entirety of Iranian oil from the market. So, the general uptrend remains in place, with prices rising above $70 and $80 for WTI and Brent, respectively.
Treasury prices fell and yields rose, especially in September. The compounding of a series of better than forecast economic data lifted yields, though more so at the short-end, until the very end of Q3. As a result, the yield curve narrowed to near a decade low. The 10-year note closed above the psychologically important 3% mark before the Fed’s quarterly meeting, where a 3rd 25 basis point increase was the consensus call. Now, for the first time in a decade, the overnight cost of money is above 2%. The normalization of interest rates, a major part of the Fed’s narrative, seems set to continue in Q4.
Finally, tariffs. Concerns expressed almost daily, with new rounds of tariffs almost monthly this summer. Where we stand: U.S. threatened tariffs vs. the EU and Japan are on hold while negotiations are in process, with some progress notable, especially in lessened rhetoric among long-time allies. However, the story does not read the same vs. China, a perceived rival on more than one front. In Q3, the tit-for-tat penalties imposed had a greater impact on Chinese markets. China allowed a devaluation of the Yuan to soften the sting on exports. Will it continue? Probably not, as the currency stabilized in September.
Where do we stand? Is there a resolution in the works before the midterm elections? Before year-end? Unknowns, but important, for if another round of tariffs are in the offing in 2019, at the same time the U.S. economy is no longer ascending, then investors may take a far more cautious view of risk-on assets. In Q3, fears went mostly unrealized, and equity markets responded in kind. Looking ahead, Q4 will bring its own set of issues to the table, from the sustainability of above trend economic growth to Washington – the Federal Reserve and politics.
Midterm congressional elections will decide the balance of U.S. political power the next 2 years.