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Talking Tariffs: 2nd Quarter 2018 Market Commentary

Amid a never ending sea of news topics, there is one that has come to define the 2018 news cycle, at least from an investment standpoint. In January most people thought the primary theme of the year would be taxes after the major tax reform bill was passed at the end of last year. However, it didn't take long for a new topic to become the primary focus: tariffs.

If you have flashbacks to your college ECON 101 course when you hear the word tariffs, you aren't alone. We won't bore you by digging too deep into how tariffs work, nor will we debate the political merits of imposing and/or threatening to impose tariffs. Just understand that a tariff is a tax levied on imported goods and they are typically used to try to protect domestic products from foreign competition. The current tariff discussion started with President Trump announcing tariffs of 25% on imported steel and 10% on aluminum back in March. The goal was to incentivize US companies to buy steel and aluminum from US producers instead of importing it from other countries.

While on the surface it might seem reasonable to protect US companies and manufacturing, there are many consequences to tariffs that aren't obvious. In the case of steel tariffs, there are many automakers in the US who import steel from abroad but who manufacture their cars here. When you raise the cost of the steel they use to manufacture cars, these companies are forced to either raise the prices of the cars or move the manufacturing out of the country.

Imposing tariffs on one product will often lead other countries to impose their own tariffs on other products. This is what we've seen happen as countries around the world have announced their own retaliatory tariffs on American goods. This is what you are commonly hearing described as a “trade war” as competing countries strike back at each new tariff with one of their own. Regardless of where we go from here, we know the tariff talk so far this year has led to a much more volatile market environment than we saw last year. While this type of volatility is more "normal" historically, it feels more painful after going through an unusually calm 2017 in the markets.

In terms of performance, the tariff talk has so far had its biggest impact on international markets. While international stocks outperformed US stocks in 2017, so far in 2018 they are in negative territory while the overall US market is up about 3%, as measured by the Russell 3000. Emerging markets stocks have been hit the hardest with a loss of close to 10% in the second quarter, putting them down over 7% year to date. Developed market stocks, as measured by the MSCI EAFE index, were down just under 2% for the quarter and are down close to 3% year to date.

In the US, small cap stocks have outperformed large cap stocks as the Russell 2000 is up almost 8% year to date compared to less than a 3% return from the S&P 500. This makes sense in light of the tariff talk as smaller companies tend to be less tied to the international trade system than large companies. Growth stocks, led by the technology sector, continue to outperform value stocks as the S&P 500 Growth index was up 7% year to date and the S&P 500 Value index was down 2%.

Real estate had a very strong second quarter as the major REIT index posted an 8.5% return to put it in positive territory for the year to date. Commodities advanced slightly on the quarter and are about even on the year so far. Inflation has picked up some this year but is still just around 2% on a year over year basis, which is right in line with the Federal Reserve's target and below the long-term historical average.

The economy has continued to pick up steam and is benefitting from the corporate tax cuts that were the primary focal point of the tax reform bill passed last year. As the economy continues to hum along, the Federal Reserve raised its benchmark interest rate again in June by 0.25%, marking the highest level since 2008. As interest rates rise, the value of bonds fall so the major bond indices are generally in negative territory for the year, with returns of negative 1-2%.

Despite the short-term loss of value in bonds, the rise in interest rates has been beneficial for many investors. Money market funds, high yield savings accounts and CD's are all finally starting to show some decent yields for investors who have been earning nothing on their cash for years. Now is a great time to reassess your cash strategy to make sure you are taking advantage of these higher yields with cash reserves.

As we move into the second half of 2018 we'll undoubtedly hear a lot more about tariffs. In spite of a strong and growing global economy, most experts agree there won’t be any clear winners from an escalating trade war. Some markets will surely perform better than others, but nobody knows in advance which those will be. As always, it’s important to remain diversified and make sure your stock allocation includes companies of various sizes from all areas of the world.

-Chris Benson, CPA, PFS

The views expressed represent the opinions of L.K. Benson & Company and are subject to change.  These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.Please see Additional Disclosures more information.