Political theater has dominated the second quarter of 2018, as markets have fretted over U.S. President Donald Trump’s tariff moves and political uncertainty in Italy. Trade wars will likely be an ongoing headwind for markets. President Trump appears committed to his protectionist agenda and a tough approach towards China. We hope cooler heads on all sides will prevent escalation, but this issue will require close monitoring.

The dual headwinds of Italian political volatility and escalating trade-war fears have not stopped equity markets from staging a choppy rebound from their March 2018 lows. For all its mood swings, the stock market made progress in the first half of 2018, albeit less than the comparable six-month mark of 2017. The NASDAQ is still the leader, up 8.8%, with the S&P 500 up just 2.65%, compared to last year at this time when the Nasdaq was up 14.1% and the S&P 500 up 8.2%. The Dow has lagged more and is down 1.8% compared with a year ago gain of 8%. The U.S. 10-year Treasury yield has found stiff resistance to moving above 3% and the strengthening U.S. dollar has put pressure on emerging markets asset classes. 

The current stock market faces big hurdles. Trade disputes with China, Canada, and other nations threaten to raise costs for many industries and consumers. Some fear President Trump’s tariffs may trigger a full-blown trade war and a recession. The Fed has signaled four interest rate increases this year, one more than forecast at the end of last year. Foreign markets are much weaker than they were one year ago. Will these risks derail the economy and therefore the markets? Maybe, but most likely not. The U.S. economy is performing well as we approach the middle of 2018. Consumer spending is strong, corporate earnings are outstanding, the unemployment rate is at a 49-year low and the Federal Reserve (Fed) has taken tightening steps at every “press conference” meeting since December 2016. We believe the big fiscal stimulus package (i.e. tax cuts) from President Trump and the Republicans should keep the economy humming along for now. Against this backdrop, the Fed is likely to continue hiking rates to prevent the economy from overheating. But, as long as the economic-leading indicators we track continue to remain strong, and stock prices remain above their February lows, we believe the political theater is just that, theatrics.

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