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Spring 2018 Investment Outlook

The stock volatility and sudden rise in interest rates that began 2018 help inform the outlook for long-term investors. Brian Kilb and Kyle Tetting discuss the markets in a Money Talk Video. A transcript of their conversation is below.

Brian Kilb: Kyle, as the calendar flipped, we commented on how quiet last year was.  Pretty good year, but volatility was nonexistent almost. And, as we have now a few months behind us here, volatility’s back. We were right on the money with that. Pretty good January, gave a lot of it back in February. It’s going to be a little bit of a different year this year.

Kyle Tetting: Yes Brian. I think the return of volatility really has been the story so far for 2018. I think we all knew it was coming; 2017 couldn’t last. So no surprise there. And yet, I think it’s taken some people by surprise, that if you were over-allocated to stocks, if you had more exposure than you were comfortable with, well you probably now are starting to realize why we had been talking about backing off a little bit at the end of the year. Why we had been talking about making sure that you had an appropriate balance.

Brian: And yet, when you look to factors that may have increased the volatility or promoted some volatility in the first couple months, the underlying fundamentals still look fabulous. With interest rates low, earnings strong, so far so good. Just a little bit of a different reaction from buyers this year.

Kyle:   Yes, you know, we’ve gotten really good news on the earnings front. We’ve gotten some tailwinds from tax reform, some opportunity for corporations to make more money. And you know, along the way, we also now have found out that profitability continues to increase for those corporations.

Brian: Well, and what are the kind of things that could lead to diminishing earnings growth? Well, I think potentially the biggest story is labor. It’s been a pretty tight labor market, unemployment continuing to be near record lows, perhaps going to keep getting lower. At some point in time, you’d have to think that that translates into wage inflation, which starts to eat into those profits.

Kyle: Yes, and input costs could be an issue as well if we saw commodity prices really take off. Of course, we haven’t seen that yet. Just like we haven’t seen the wage inflation piece. But it is a possibility, and the Fed is doing everything they can.

We’ve already seen one rate increase this year, in 2018 – probably a couple more in the cards for this year, at least. And so, you know, I think the Fed has done a really good job of making sure that inflation isn’t an issue, but there are some things to watch there, as well.

Brian: I’ve talked quite a bit about the stock market: A big January, not-so-good February. But maybe a bigger story was the bond market. The 10-year U.S. Treasury at 2.4%, six weeks later, close to 2.9%. That’s a 20% increase in yields. That’s gigantic in the bond market. Of course, as a reminder, as interest rates rise, the price of your bonds falls – so, as much to be seen and felt in your portfolio performance in February, as there was every bit in stocks.

Kyle: And those longer-term rates might have been a little bit depressed. You know, we had gone through a period where inflation really wasn’t in the cards at all. Again, still not seeing much of it, but a little bit more now, and I think the expectation that the Fed was going to increase rates and the potential for inflation to pick up allowed those longer-term rates to increase.

And so, that can be an issue for stocks as well as bonds. Obviously, it’s a headwind for bonds because those newly issued bonds are issued with higher rates, they become more attractive to purchase, for people looking for bonds. But it’s an issue for stocks, too, because all of a sudden, if rates continue to rise, bonds can be a more compelling investment opportunity than they were relative to stocks.

Brian: You know Kyle, we have a tendency to focus mostly on the domestic story, but some pretty positive things going on overseas, as well. In terms of the underlying fundamentals still accelerating, maybe a couple years behind us in the cycle. As things become more challenging here, it might be that we get a little extra bit of a run in some of the markets overseas.

Kyle: Yeah, of course, Brian, seeing employment growth, seeing some new earnings growth, from Europe and much of the rest of the developed world. Things that we really weren’t expecting, maybe a year or two ago, that finally now are making their way into the markets. And so, you know, maybe the story of 2017 was synchronous global growth, uh, I think it’s too early to say what the story of 2018 is going to be, but some of those tailwinds continue to be present.

Brian: You know Kyle, it’s all about what do we do with our portfolios as a result of this conversation. And I think with the uncertainty, perhaps growing uncertainty, it’s really a good reminder of the place bonds have in your portfolio: Safety, keep you out of trouble.

Maybe we’ll get a little bit of a surprise in stocks this year, and make some money, but I think we want to be careful in terms of the opportunity set continuing to diminish a bit. Just a little caution, perhaps, is warranted.

Kyle:   Yes. The start of the year was such a great example of the important of balance. And I think investors now really need to be in tune with what their tolerance for risk is. You know, if you haven’t looked at what you have in a while, if you haven’t seen what your asset allocation is, now’s the time to do that.

Brian: It’s good to keep that in mind as you build a balanced portfolio and we play out the remainder of this year.

Brian Kilb is president and chief operating officer at Landaas & Company.
Kyle Tetting is director of research at Landaas & Company.
Money Talk Video by Peter May and Jason Scuglik

Learn More
Volatility is back: What you should know, a Money Talk Video with Dave Sandstrom
Watch credit quality as spreads narrow, a Money Talk Video with Marc Amateis
Over There: Investing in a global economy, a Money Talk Video with Kyle Tetting

(initially posted April 2, 2018)

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