Third Quarter Market Review

We always live in an uncertain world. What is certain is that the United States will go forward over time.” ~ Warren Buffett, CEO Berkshire Hathaway, CNBC on 9/22/2010.

On August 22nd, the current bull market became the longest on record since World War II.  While interesting to note, the quote above was issued over a year after the bottom of the market (March 9, 2009), a point in time when pessimism about the U.S. economy was still widespread.  Investors would have done quite well to listen to Mr. Buffett’s sage advice, as the S&P 500 is up over 420% since the March 2009 lows, and this quarter served to show the strength and resiliency of the U.S. economy 9 years after the Great Recession.

Third quarter results were highlighted by a plethora of positive economic data that helped U.S. equity prices head higher. Broad-based economic growth was the main theme this quarter, as final estimates of GDP increased 4.2% in the second quarter, the fastest growth in roughly four years. The narrative that growth could support equity prices in the near term was further supported by a strong labor market that continues to tighten, as nonfarm payrolls hover around 200,000 (twice what is needed to keep the unemployment rate stable), while August average hourly earnings approached the highest level this cycle at 2.9%. End-market demand continues to be strong as the August ISM manufacturing index posted its highest level in 14 years, driven largely by new orders. Small business optimism surpassed a previous record not seen since 1983, while consumer confidence hit a high in September. Suffice it to say, the U.S. economy is firing on all cylinders, this is despite media attention toward elevated trade tensions, geopolitics, and rising interest rates. That being said, we would not be surprised to see a pullback in the equity markets given how far the economy has come in such a short period of time.

U.S. equities were the bright spot this quarter, outperforming their international peers; however, the robust U.S. economy was not the sole driver of higher prices. Solid corporate earnings, aggressive share buybacks from corporations, and continued tailwinds from tax reform provided the backdrop for S&P 500 earnings to increase 25% last quarter, the highest rate of profit growth in almost eight years. Strong profits only tell part of the story as reported revenue growth was up over 10%, the highest in seven years. Corporations continue to aggressively buy back shares of their stock, as Goldman Sachs estimated a 50% increase from the prior year in buybacks through the first half of the year, on pace to set a new full-year record at over $1 trillion dollars.

Emerging markets and commodities were the weak spots this quarter, as the strong U.S. dollar, coupled with fears of increased borrowing costs for emerging market countries holding U.S. debt, put pressure on these equities. China and U.S. trade tensions did not help the matter, while the currencies in Argentina and Turkey came under pressure due to rampant inflation.  Despite these risks, emerging markets were down just over 1% in the quarter. 

Growth Oriented (Equity) Benchmarks

Category Benchmark Q3 2018 1 Year 3 Year 5 Year 10 Year
Global Equity MSCI All Country 4.28% 9.77% 13.40% 8.67% 8.19%
U.S. All Cap Russell 3000 7.12% 17.58% 17.07% 13.46% 12.01%
U.S. Large Cap S&P 500 7.71% 17.91% 17.31% 13.95% 11.97%
U.S. Small Cap Russell 2000 3.58% 15.24% 17.12% 11.07% 11.11%
International MSCI EAFE 1.35% 2.74% 9.23%   4.42% 5.38%
Developing Markets MSCI Emerging -1.09% -0.81% 12.36% 3.61% 5.40%
Commodities Bloomberg -2.02% 2.59%    -0.11%   -7.18% -6.24%
Global REITs NAREIT Global -0.78% 2.95% 7.75% 6.15% 6.69%

Note: All benchmark results for periods longer than one year are presented as compound annual returns. Benchmark returns do not include fees.

Fixed income returns were largely flat this quarter, as Fed Chairman Jerome Powell and the Federal Reserve walk a tightrope of increasing interest rates given a healthy economy while not overstepping and raising rates too quickly. There were no major surprises this quarter, as the Fed raised rates by an additional quarter of a percent.  More notably, the Fed’s commentary removed the words “accommodative” from their language and have indicated they are still on track to raise rates again in December, and possibly three more times in 2019 due to the strength of the U.S. economy. The shift from quantitative easing (“QE”) to quantitative tightening (“QT”) is an unenviable job for the Federal Reserve, but liquidity is still in the system given the Fed’s balance sheet, which stands at over $4 trillion. The 10-year Treasury yield pushed past 3% at the end of the quarter, while the yield curve flattened as rising short-term interest rates increased faster than long-term rates.

Income Oriented (Bond) & Cash Benchmarks

Category Benchmark Q3 2018 1 Year 3 Year 5 Year 10 Year
Global Bond Market Barclays Global -0.05% 0.82% 2.35% 3.13% 4.07%
U.S. Bond Market Barclays U.S. Aggregate 0.02% -1.22% 1.31% 2.16% 3.77%
Municipal Bonds Barclays Municipal -0.15% 0.35% 2.24% 3.54% 4.75%
Cash 3 Month Treasury Bill 0.50% 1.57% 0.80% 0.49% 0.32%

Note: All benchmark results for periods longer than one year are presented as compound annual returns. Benchmark returns do not include fees.

While the news channels and market pundits touted elevated trade tensions and uncertainty going into the midterm elections as possible near-term dangers, the market largely downplayed these fears and their associated geopolitical risks. While the market got it right in our opinion, we do believe a diversified and balanced approach to portfolio management is of utmost importance in any market environment. As Mr. Buffett stated, uncertainty in the market is an ever present threat, but is nothing new. A steady and long-term perspective can handsomely reward those that cut through the noise.

As always, we thank all our clients and friends for your continued trust and support of Madison Wealth Management.

Important Note: This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Madison Wealth Management does not provide tax, legal or accounting advice.© 2018 Madison Wealth Management