The performance of the equity markets the first half of the year shares similarities with two recent flights leaving Australia.  Perhaps you heard about them?   

Last week, passengers boarded Qantas flight QF33 en route from Perth to Paris.  After a great deal of travel, ups and downs, and likely turbulence along the way, some 15 hours later, passengers found themselves back to where they started in Perth.  While already en route, several countries closed their airspace due to the Iranian conflict.  Therefore, the airliner returned home without accomplishing a whole lot.  Fortunately, the passengers and crew all returned safely, albeit likely tired.

The U.S. domestic equity markets followed a similar path.  After a significant rally to all-time highs in February, stocks retreated approximately 20% through April, only to return to previous all-time highs near the end of June.  In the end,  domestic equity markets were not much different at mid-year than they were at the start of the year.

Fortunately, flight schedules and routes returned to normal soon thereafter allowing passengers to move toward their desired destination.  Will the same be true for equity investors for the second half of the year?

 We believe the market ultimately reflects corporate earnings, the outlook for those earnings, and the multiple investors are willing to pay for those anticipated earnings.  Corporate earnings are influenced by many factors.  Currently, there seems to be many macro issues that could impact corporate earnings and therefore the equity markets.  The following are currently of great significance:

• Twenty-two times  - The S&P is currently trading at a lofty 22 times forward earnings, according to FactSet.  This is high relative to the five-year average of 19.9 and the ten-year average of 18.4.
• The uncertainties continue - Markets are trading at a higher multiple at the very time uncertainty is heightened.  This is atypical.
• Taxes – Lower taxes flow to the bottom line of corporate earnings and individuals.  Conversely, higher taxes detract from corporate earnings and individual net income. Therefore, any changes in tax policy can be of significance to the markets, and earnings at the corporate and individual level.
• Tariffs – are like taxes.  Corporations with an inelastic demand can pass along higher expenses to consumers which perpetuates higher inflation, at least initially.  Alternatively, corporations can absorb the higher cost and this impacts corporate earnings making the market even more expensive on a valuation basis.  Or, corporations make cutbacks in various areas – such as employment, research and development, etc… likely hurting longer-term prospects and ultimately earnings. Then again, corporations might do a combination of some, or all, of the above.  Tariffs are not friendly to the markets, in general.
• Tariffs – devil’s advocate.  What if the anti-free market / free-trade stance and policies along with tariff rhetoric actually works?  In other words, what if imposing tariffs eventually results in lower barriers of entry and creating greater free-trade?  Should free-market capitalism return in a more robust way, one would anticipate the economy and markets rallying.
• The Federal Reserve – imagine being on the FOMC and deciding interest rate policy for the Central Bank of the United States.  Too many unknowns to likely change course soon.  However, if employment data comes in weaker tomorrow, a rate cut will likely come sooner than later.  We might find ourselves in a bad news is good news environment, once again.
• The US Dollar  - Tariffs, interest rates, trade, deficits, and debt levels, can all impact currency rates. The US Dollar has weakened significantly of late.  Although weaker, we still believe the US Dollar to remain the fiat currency of the world for many years to follow.  Investors continue to flock to US Treasuries during times of uncertainty.
• The level of US debt is concerning  - However, debt service remains manageable.  As Powell said, “The U.S. federal budget is on an unsustainable path. The debt is not at an unsustainable level, but the path is unsustainable, and we know that we have to change that.” Eventually, there will be a price to pay.  The question is when.
• Tensions in the Middle East – another significant uncertainty which could sadly impact both human life and free trade.  There are many potential ramifications including trading routes. Escalation would be of great concern to the markets, energy prices, and general uncertainty.
• Timeline – an investors time horizon is incredibly important during times such as this.  If one has a need for cash in the next 12- 18 months, it is likely prudent to de-risk and hold a higher cash position than normal to cover anticipated cash flow needs. On the other hand, if investments are longer-term in nature, then holding the course seems prudent due to the possibility of higher corporate earnings in the future.
• This time of year – often times the markets are more erratic than usual with the lower trading volumes during the summer months.  Historically, the market experiences weakness during the summer – especially August and September.  We do not recommend moves based upon this historical pattern due to the many exceptions to the rule but rather use this as a background factor when assessing the outlook and direction of the markets.
• Trump – agree, disagree, or somewhere in between.  It is difficult to calculate what might happen next.  Should the administration focus on pro-growth business friendly areas such as deregulation and lower taxes, resulting in an improved economy, then markets are likely to move upward.  However, should the focus be on tariffs and deportations, there will likely be greater uncertainty and fewer workers at a time when the country is in need of a more robust labor force.  Mass deportations might result in a wage spiral whereby higher labor costs create higher expenses which result in higher inflation over a prolonged period.
• Tracking policies are important  - We believe it prudent to track changes in policies and therefore potential outcomes.  However, we continue to believe that allowing one’s political ideology to influence investment decisions rarely works out.  This is due to human nature to see things overly optimistically or overly pessimistically based upon one’s belief system.  Our goal is to be apolitical and to focus on fundamentals.

Upon further reflection, perhaps another flight from Perth might be more illustrative of the first six-month of the year.  This flight was from Perth to London.  This flight also turned back due to the same airspace issues, last week.  However, this flight made an emergency landing in Singapore.  In other words, it did not go all the way back to where it began but rather made some progress toward its final destination.  This is what the first six months brought us, this year.  We will be watching closely as we chart the path forward, analyzing, making predictions and adjustments, for the next six months, sixteen months, six years, and beyond in the future. 

A few personal observations.  Robyn and I charted Ashley’s return flight from her study abroad semester in Australia with great interest. Her Qantas flight was taking place as the US became involved in the Iranian conflict.  We can only imagine our concern had we watched the flight turn around mid-route. Fortunately, she made it back home safely without issues.  We are thankful for that.

Thank you!  Without you, life would be much less fulfilling.  We love what we do and for those we are able to serve!  Thank you for allowing us to work with you and your life savings!  We are honored to do so!

Lastly, at a time of great uncertainty, many unknowns, and sadly division in our Country, we are reminded that despite all of the problems we face at home, we remain thankful to call the USA – the land of the free, and the home of the brave  - our home. As we celebrate the Fourth of July, we are reminded of all we have in which to be thankful.  May better times be ahead and may we find comfort in knowing we Americans have more in common that unites us than divides us.  May God continue to bless the United States of America! Happy Fourth to you and yours!