After a volatile start to the first half of the year, U.S. Equity returns rebounded in the third quarter on strong corporate earnings and solid U.S. economic growth. U.S. stocks rose to new record highs, supported by a long-running rally in the technology sector. In fact, Apple became the first company in the world to reach $1 trillion in market capitalization. This quarter also marked the longest bull run in its history, surpassing the previous record bull market that ran from 1990 to 2000. Outside the U.S., markets were generally flat, to down, amid investor worries over deteriorating global trade relations and a strengthening dollar. It’s been especially tough for emerging markets, which fell in the quarter, undercut by a strong U.S. dollar, financial troubles in Turkey and uncertainties over how China’s government will resolve its trade dispute with the U.S.

The challenging questions to answer are how much further trade tension will rise and what its impact will be on trade, economic growth, corporate profits and inflation. Wage pressures in the U.S. are finally picking up and this is being reflected in a slightly more aggressive outlook for the Fed, and in higher interest rates. In September, the Federal Reserve hiked policy rates for the eighth time this cycle, pushing up short-term rates and causing the yield curve to flatten. The curve, however, remains positively sloped and steep relative to prior late cycles, and U.S. credit and financial conditions have yet to tighten measurably.

Looking forward, the fourth quarter should be an interesting one with many risks to contend with. We have poor seasonality to deal with in early October, but then earnings season starts and the mid-term election will quickly hit. There is going to be tremendous market speculation about control of the Senate and what it means to the market. The pundits have done a very poor job of predicting market moves based on politics and that is likely to continue. Third quarter GDP will be reported soon and will be quite strong, the Fed should raise rates again in December, and the trade war issue doesn’t seem likely to go away any time soon. And as strong as earnings have been, we believe the hurdle for U.S. earnings to surprise on the upside is also now very high. The impact of corporate tax cuts on earnings will soon disappear. A slowdown in earnings growth will take away one of the main supports for U.S. outperformance relative to other markets. But so far, the markets have shrugged off any bad news or perceived risks as investors have become conditioned to buy negative headlines. Until that dynamic changes, along with some weakening in our macro outlook, we continue to expect corrections to be limited to just “noise.”

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