By The Trust Company on October 18, 2018
THIRD QUARTER IN REVIEW
The third quarter proved to be very strong for domestic stocks. Corporate earnings continued to soar on the heels of corporate tax cuts, consumer spending, and global growth. Toward the end of September, a new round of reciprocal tariffs between the United States and China kicked in as it appears neither economic giant is ready to flinch.
For the third quarter, each of the indexes listed here posted solid gains, led by the large caps of the Dow and the S&P 500. The tech-heavy Nasdaq continued its strong showing while the small caps of the Russell 2000 posted moderate quarterly gains.
Eye on the Month Ahead
The summer months proved full of volatility for stocks, as investors were inundated with negative rhetoric between the United States and several of its trade partners. The last quarter of the year is expected to bring much of the same. The economy enjoyed robust growth during the second quarter, according to the gross domestic product. Will growth approach 4.0% in the last quarter of the year? If consumer spending continues to expand as it did during the summer months, economic expansion could equal or surpass third-quarter growth rate.
As of this writing, the Forward P/E of the S&P 500 is 15.2X next year’s earnings. The selloff at the start of October has brought the Forward P/E below where we started the 3rd quarter. The Free Cash Flow Yield currently sits at 4.9% (higher is better) which is higher (a positive sign) than the historical median. While there are near-term risks, stocks still appear to be more attractive relative to other asset classes. We have maintained our overweight position in Equity.
We have maintained our underweight in Fixed Income. The yield curve flattened more in the 3rd Quarter down to a spread of 0.39% between the 2-year and 30-year Treasury. Though the start of October has seen that spread widen back to where the 3rd quarter started. Expectations are for the Federal Reserve to raise rates again in December.
If the economy continues showing signs of strength, we would look at pullbacks as buying opportunities. While it is our expectation that the Fed will continue raising rates in 2019, we are still low by historic standards. There is some risk that continued rate hikes could stall the economy. If they continue to do a good job of advertising their actions and stay with a measured pace, we think the economy should be able to absorb higher rates.
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