October 4, 2018

The U.S. stock market continues to soar. As we write, the S&P 500 Index is near all-time highs. For the past six months, returns have been positive. From a bigger perspective, this bull market (a market characterized by rising prices) is now the longest since World War II. The S&P 500 is up over 300% since its low in March 2009. To break this streak, markets would need to drop by 20% or more—something we have not experienced in over nine years.

The domestic economy is also strong. While we believe the current economic expansion to be somewhere in its later stages, economic indicators remain impressive. GDP (Gross Domestic Product), a measure of economic growth, hit 4.1% this summer. This is the highest quarterly level since 2014. Consumer confidence is at an 18-year high. In August, small business optimism scored the highest it ever has according to the 45-year track record of the NFIB Small Business Optimism Index. On the whole, small businesses plan to expand operations, hire workers, and increase wages. Across the economy, unemployment remains extremely low, creating a tight labor market.

At Clifford Swan, we realize that while stocks have historically increased over the long term, shorter-term market behavior is more volatile. Periods of strong returns are inevitably accompanied by weaker ones, at some point in time. We do not know with certainty when markets will weaken. However, we are staying closely attuned to a variety of market signals and indicators. A couple stand out to us as key to watch.

The first is trade. Trade protectionism has been a headline for much of 2018, as the Trump administration moved to enact tariffs and redefine global trade relations. Overall, the stock market has been resilient to fears about negative trade outcomes, but where we have seen downward market movement in 2018, it has generally been accompanied by trade anxiety. As we write, the U.S. has announced a trade deal with Mexico and Canada to modestly revise the North American Free Trade Agreement (NAFTA). If ratified, this should allay some uncertainty regarding trade amongst our allies. However, markets remain focused on trade relations with China and potential negative outcomes for U.S. businesses and consumers. So far, we perceive the impact on domestic corporate earnings as minimal.

Inflation is also top of mind, as a tight labor market is often a harbinger for inflationary pressure. When workers are scarce, wage growth often results. We may also experience parts shortages as demand exceeds supply. While a certain amount of inflation is generally good for the stock market, high levels can be disruptive. As a result, we are watching inflation closely. We do not think an inflation inflection point has arrived, where levels have risen too quickly, though this could change. To mitigate inflation risk in our portfolio management work, we focus on companies with strong pricing power and healthy balance sheets.

On a housekeeping note, this past month brought about structural changes in the S&P 500 stock sectors. Among other changes, the Telecommunications sector was renamed Communication Services and its membership expanded. This change reflects the evolving nature of the global economy, where a variety of companies now facilitate communication and distribute content through different media types. This change does not affect our stock selection process, as we evaluate companies and their markets according to our own analysis rather than market labels.  

The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.

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