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A Zero-Sum Game

July 3, 2018, 10:00 am

The first half of 2018 ended roughly where it started, with the broader market indices within 2% of breakeven after some wild action as Wall Street bickered about interest rates and asset prices. Back in January, we were mulling the impact of the biggest corporate tax cut in a generation, and here at the end of June some investors are wondering if a looming trade war will take away all the stimulus that lower taxes created, leaving the economy right back where it began.

For a lot of index fund investors, 2018 has been a zero-sum game.  The correction in February kept a lot of stocks sidelined for months. Some sectors remain defensive at best, with talk of tariffs in March effectively pushing export-oriented corporate giants into a secondary decline that persists to this day. Great companies like Walmart (WMT), Johnson & Johnson (JNJ), Boeing (BA) and Caterpillar (CAT) are now in bear market territory.

Tech was an obvious profit center for everyone in the market. The technology-rich NASDAQ has certainly suffered in the last few weeks, but that’s because there’s actual profit in Big Tech for traders to take with the index up 8% year to date.

With other sectors struggling to overcome the shadow of restrictive trade policy, a lot of money has crowded into tech. That crowded trade can generate unusually high levels of volatility when the crowd shifts. Last week, we saw a shift to the downside, taking the NASDAQ down about 3% from its recent record and spreading clouds across other “risk” themes like biotech. This week, the move is as likely to go in the other direction.

Looking forward, I think the next cycle will be extraordinary. Despite the zero-sum game for the S&P 500, the Federal Reserve has raised overnight lending rates twice so far this year and we can now expect another two hikes between September and December. That’s a windfall for banks, even if stocks have yet to reflect it. It’s also a clear sign of the strongest economy in a decade – gross domestic product (GDP) is tracking 4.8% growth in the current quarter, which is a bona fide boom that should lift most, if not all, corporate boats no matter what happens overseas. We’re looking for 20% earnings growth when the season starts in two weeks, which is fantastic.

The next few weeks could remain bumpy, with slightly elevated volatility across the market and pockets of extreme volatility around certain stocks. When earnings season kicks off, it may come as a relief and confirmation that corporate America is doing extremely well, which will be a good thing for shareholders.

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