Last month we stated, "Seasonal jitters can really get to investors who are already nervous." This idea seems to be the bulk of what drove the markets from mid-June and forward, as the growth in the markets clearly went away in the second half of the month. Many seem to be trying to pin the "Tariff Tail" on this donkey. However, if we remember the market downturn which began in late January, it had nothing to do with tariffs and seemed to have everything to do with unexpectedly large wage increases. The downturn from January through early February was approximately -12%, top to bottom.

As of Late.

The early days of June showed a lot of promise for stocks to deliver an outstanding month of returns. As we approached mid-June, those desiring an outstanding month saw their hopes go down about as quickly and methodically as stock prices did. The S&P 500 and NASDAQ indexes ended the month of June with negative returns, as you can see in the graph below.

While many have inferred that the market struggles of June are directly related the the "tariff talks" currently circulating the globe, we see a very different motivation for stocks lagging returns--growth--which seems to be absent worldwide. While there are many who are concerned about what might happen if tariffs are imposed in 2018 by various countries, tariffs do not fully explain why the markets have struggled since the final week of January to move up with any real strength.

We see that the strength we entered the year with has seemingly dissipated and continues to leave the U.S. markets. All this is largely due to the widespread set of data points showing that there is no global growth going on presently. While this affects the U.S. markets only moderately now, there is likely more impact yet to come. This graph shows that for the first six months of 2018, stocks have gyrated around a noticeable amount. Despite all this risk, there is less than a 1% gain in the S&P 500.

What we are witnessing now is a true lack of the "global synchronized growth" the market pundits have been discussing for many months. What we have seen is a "global deceleration" by many of the largest economies across the globe. Despite all the financial news anchors trying to "talk up" an already elongated rising market, the global story tells a different tale as of late.

We can see in this graph below, showing the Purchasing Managers' Index (PMI) of our largest 5 trading partners (China, France, Germany, UK and Japan), that since late 2017/early 2018, the PMI has been falling in each of these countries, which is not a good sign. If purchasing managers are planning on buying less, then fewer work hours will be needed to produce the goods/services managers will be buying. This leaves the consumer, working less hours, in a pinch. When this is happening on a global scale, as it is right now, it is not good for anyone.

PMI Measures for our largest five trading partners.

As we can see in the graph below, the U.S. is in better shape than any of our largest trading partners when it comes to PMI measurements. In the last eight months, the U.S. has only had one month (April) in which the PMI was lower than eight months prior. In addition, the U.S. PMI is higher in each of the past 12 months. Japan is the only U.S. trading partner that is higher than it was 12 months ago.

The strength of the U.S. engine cannot keep this market afloat on its own for long periods of time. The drag on the U.S. by both large and small trading partners is starting to take its toll. Markets here in the U.S and the toll being taken on our markets by our trading partners will continue to grow over time. No recession appears to be on the near-term horizon (before the end of 2018). However, a recession could be looming in late 2019 or early 2020.

So what is on the rise in terms of investments?

We stated in our last newsletter, "we are seeing some 'rotations' in the types of stocks that are performing well..." We then made comments about large cap stocks slowing their growth and “small cap stocks” lead the way, followed by “mid cap stocks”. This remains true in the current time frame. One part of our data set put on a "BUY" very early this year in the small and mid cap stocks (commonly called SMID), and another portion of our models gave us a "BUY" on small cap stocks in mid-May. Both of those holdings we still hold today, and they both are up more than the S&P 500 as of the end of June.

Additionally, the value of the U.S. dollar on the world market has been rising for the last 7 weeks after it bottomed in very early May. Our model signaled a "BUY" on the U.S. dollar in early May, and while it is not usually going up like a bottle rocket over time, it has steadily increased and is ahead of stocks in its growth since our "BUY" signal date. Also, U.S. Government bonds have been rising some in value lately. When the year started, "falling bond prices set against rising interest rates" was the constant chatter heard through the "talking heads" on Wall Street. While bonds are still slightly negative for the year so far, the months of May and June both showed a nice rise in the price of bonds by just over 3.5%; certainly outperforming stocks. Lastly, we have seen some rise in publicly traded real estate investments. Nothing too crazy, but there are some improvements in pricing of some properties.

The Long-Term View.

Typically the constant mantra which Wall Street puts out goes along the lines of, "Stocks beat bonds in the long run every time." Yet, as we showed last month, stocks have been lagging behind long-term government bonds for almost two decades. Only recently have stocks risen enough to match the long-term return of U.S. Government bonds.

U.S. Government Bonds vs S&P 500 since the beginning of 2000

Although there have been individual years when stocks outperformed bonds, as you can see in the graph above, stocks never had the advantage in overall total return until now. Furthermore, stocks handed investors plenty of risks during this full time frame, being well below where they started in 2000, something bonds never suffered from since 2000. All the above is shown on a passive investing basis.

Over the long run, the S&P 500 has not generated what many would consider "strong" returns for those who simply “buy and hold” the overall stock markets. I often find people have romanticized the history of market returns, seemingly glamorizing the great years and diminishing the memory of the not-so-great years. All returns shown below are adjusted for inflation.

10 Years           15 Years           Since 2000        20 Years
S&P 500 Ann Ret. 5.89%/yr. 4.81%/yr.          1.42%/yr.          2.39%/yr.
(w/dividends included) 8.09%/yr. 6.89%/yr.          3.33%/yr.          4.27%/yr.

When managing investments, it is essential to have some type of process which can help one stay abreast of the risk(s) they are constantly taking. Are the risks you have greater than the risks you want or need? How much risk one wants and needs should be determined prior to investing, rather than during the investment cycle. When markets are going up, most people just sit back and enjoy the ride. They are often unaware that risk is rising too, sometimes faster than one might think.

We remain watchful.

Ken Graves, Chief Investment Officer
Capital Research Advisors, LLC
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The month of June moved slightly lower for U.S. stocks but it seems stocks are still shaking from the February sell off.

We remain watchful.

Mortgages:

Lending rates are still extremely low by historical standards.

It has been most interesting to me over the last month or two to find I have so many people in my life who are what I would refer to as "tariff experts". I am joking of course, but so many people want to weigh in rather adamantly about "these crazy tariffs" or the "tariff wars we started".

Man 1- Bank 0

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