The week ending June 15 was relatively light on economic data, and heavy on big macro and headline grabbing events. There were no shortage of punches thrown at the market. Aside from the Fed meeting, which resulted in making good on another well-telegraphed interest rate hike (caught no one off guard), there was also the much anticipated summit between North Koreas Kim Jong Un and President Trump; as well as signal from the 2nd most important central bank, the ECB as to whether it will conclude its program of quantitative easing and begin the task of balance sheet contraction. On the former topic, the summit was light on specifics but symbolizes a show of de-escalation of sometimes hostile tension between N Korea and the rest of the world (namely the US). That development is certainly not a market negative. On the ECB, a change of course and path toward policy normalization brings back memories of the Taper Tantrum experienced when the same notion was floated in the US several years back. Yet in a world where the US continues to normalize policy and so many others remain accommodative, the gap between world policy continues to stretch. Things that stretch too far usually break, and right now the stretch is creating financial stress for emerging markets due to the strengthening implications for US dollar denominated debt and trade. So in this case, the broad market may applaud actions that relatively tighten non-US monetary policies and begin to narrow or at least stabilize the perceived gap. Still, tariff and trade-war worries received another douse of fuel as the Trump administration announced it would move forward with tariffs on select Chinese imports.

All told, the events and data (which continues to suggest the economy in the US is chugging nicely in 2Q) yielded a market result that was roughly flat for the week ended June 15. As a matter of fact, it was actually the narrowest weekly trading range for the markets for the entire year. Each of the major headline events of concern to investors leading into the week went largely as expected and in-line with consensus; thus there were no big surprises for the markets to digest. As far as the US yield curve goes and the flattening it is experiencing, it is important to note that the curve remains upward sloping. While worth monitoring closely, the important distinction that it remains positive sloping would suggest time remains in the current cycle. We remain constructive on the economy at the moment, but believe choppy trade through the summer months and US midterm elections is probable.

Indeed, it appears there is a rotation in sentiment underway. Whereas investors were excited by returns offered by international investing during 2017, sentiment toward the same group feels sharply less favorable this calendar year. It is not difficult to understand why: trade, tariffs, and geopolitical situations highlight why investing abroad feels more uncertain and unsettling than staying domestic. And economic data while resoundingly still strong in the US has looked less convincing if not toppy abroad. And while the perspective that international economies are arguably earlier in their economic recoveries than is the US, the political dynamic and economic trajectories among individual countries are far more bifurcated than can be said of here in North America. The brief shock experienced at the end of May wherein anxiety spiked over Italian politics and implications for its EU membership and overall debt are case in point. Headlines like those are nearly impossible to handicap from an investment perspective. Another perfect example relates to where all eyes are fixated entering this 2nd week of June with the much anticipated meeting between President Trump and N. Korean leader Kim Jung-Un.

Geopolitics, investor preference, and sentiment aside, the backdrop which persists of strong economic data set against what were lofty investment multiples (valuations) entering the year continues to suggest 2018 may well turn out to be a year in which the major indexes underperform the broader economy. In asset manager terms, alpha rather than beta will be the measure of success. In fact, some suggest major indexes may make little upward progress over the next six months. This is not to suggest a bearish or negative outlook; rather it seems increasingly probable that active rather than passive approaches to investing will be rewarded. In an investing climate where the focus is increasingly on fiscal rather than monetary policy developments, it is likely to again matter more what you did or did not own rather than simply own everything via an index because fiscal policy changes have a way of picking relative winners and losers in a diverse economy. In the short-run, be careful to acknowledge that the dog-days of summer are upon us where volume typically gets sleepy and news items have a way of driving markets more than they otherwise might.

Economically speaking, data continues to support the notion that inflation and interest rates are going up but the pace of change for both so far looks manageable. The latest installment of retail sales data was solid, and key manufacturing and industrial production indices were also a support. Housing data however was more mixed. Corporate earnings season is winding down, and with over 93% of S&P500 companies reported it appears as though the aggregate level of earnings will top the same period a year ago by more than 20%; this is noteworthy because no recession has ever begun when corporate profits were still rising.

A key theme so far in 2018 is the question of whether this (economic growth and corporate earnings) is as good as it gets? Indeed, most data is quite robust and the consensus of market participants believes that we are late in the business cycle. It is undebatable that in terms of time, the US cycle is extended based on historical standards. Casting the proverbial shot clock aside, there are still quite valid arguments that pent-up economic demand remains and there are several catalysts for how that demand might ultimately be unleashed. Those catalysts include getting full employment in the US; government fiscal stimulus (tax cuts, full expensing of corporate capex), rising velocity of money due to some awakened inflation (you buy today because you believe goods, houses, etc. will only be more expensive in the future); and/or more investment of corporate cash. We remain of the perspective that the fundamental backdrop is more supportive of a continued upward sloping equity market trend. Yet the summer months are unlikely to be as sleepy or calm as last when considering it a mid-term election year and an environment that looks setting up for significant incumbent party losses. And an already tarnished Trump administration may have even more challenged days ahead should republicans lose control of the House. That reality is likely to keep waters choppy for investors. In the shorter run, while nearly two weeks of trading remain the often repeated mantra of sell-in-may and go away would, at least so far, result in missing some of the best performance since the correction that began in late-January. Should the month conclude in positive territory, it is yet another perfect example how one cannot create a successful, repeatable investment discipline based on the calendar or number of worrisome headlines crossing the tape.

From an economics perspective, the most encouraging news last week was the message from data revealing that inflation, while up, does not appear to be running away. Consumer and business sentiment also remains elevated. Spring housing season looks set to be in respectable shape as well despite notably higher borrowing costs vs. a year ago as applications for home purchase are not as soft as feared. Too, with more than 90% of S&P500 constituents reporting, approximately 75% have beaten both earnings and revenue estimates. Better than expected revenues suggest that it is not just a one-time accounting windfall from recent tax cuts propelling 1Q results. It also stands to reason that corporate plans for cash will develop beyond share repurchases which received significant media attention last week (share repurchases return cash to shareholders and generally offer short-run support for equity prices). Investments of capital if made, rather than returned to investors, become another companys revenues. Beyond data however, one could ask most anyone on Main Street their take on the economy and it seems likely they would perceive the economic world around them as appearing quite strong. This is important because in an economy as large as the US, trends do not turn on a dime.

Despite an economic backdrop that would still appear favorable, domestic and international equity markets remain choppy to-date and the wall of worry for the market is substantial. The noteworthy concern from a month back as to whether we are experiencing peak earnings growth seems to have morphed into a more troubling fear of peak earnings PERIOD. Additionally, recent US$ strength and rising bond yields are creating financial stress for emerging markets while at the same time international growth is appearing toppy recently. Closely watched too is the slope of the yield curve, which continues to flatten and appear on a path toward inversion. Yet while an inverted yield curve has the strongest historical correlation to economic recession of almost any indicator, inversion typically occurred between 12 and 18 months on average before an economic recession. It is in that vein that all things considered, there is still some runway left for this economic cycle. And, in the short-run it feels at least as if the number of negative headlines about trade and geopolitical tensions might be softening. Still, we are careful to note that financial markets do not always mirror the economy and for now at least it would seem as though the US economy is in a strong position to outperform the stock market in 2018 even if the worst of the market correction that began in late-January might be behind us.

From a fundamental perspective, the weekly flow of economic data remains generally supportive. Weekly jobless claims fell again and the labor market appears quite healthy. While positive, this data series continues to fuel concerns that inflation via wage growth simply must pickup and there is evidence supporting this. The ECB was also mildly dovish on interest rates. The big story in recent weeks however is how strong is 1Q earnings season so far. With roughly a third of the S&P reporting, 78% are beating on earnings and 68% are beating revenue projections as well. If continuing at this pace, the overall level of S&P earnings for 1Q stands to be up between 15-20% over the same period a year ago. It is true that some of this is related to tax-cut related gains, but these are still real profits that can be utilized by corporations to invest in future productivity (or less desirable stock repurchase programs). Also recent earnings inputs are so robust it would seem impossible to last at this pace for long. In that vein, several companies are choosing to try and rein in investor expectations and avoid setting expectations too high. Fundamental data is not without its misses either however; recent data out of Europe is at times recently appearing toppy and China is witnessing slowdown. Global industrial share prices are weakening on a relative basis, which probably has at least as much to do with sharp tariff talk as it does with any actual change in demand as recent commodity price gains suggest economic activity is doing anything but tapering off at present.

At present, the wall of worry for the market remains substantial. Interest rates are continuing to rise, the yield curve is flattening, trade wars and tariff deadlines are looming, and domestic political uncertainty seems likely to increase as we move toward mid-term elections later this year. All these come at the same time as pessimists posit that we are witnessing peak corporate profit growth and the 2018 personal income tax cut is being saved by consumers rather than utilized to consume (so viewing current positives as future negatives). While for the moment it appears the stock market cannot find direction, we continue to believe there is still momentum in this business cycle. We would view that investor sentiment deteriorating and well off what was often argued as complacent is a positive. Further while monetary policy is certainly tightening in pursuit of policy normalization, history reveals that interest rate increases are actually a positive for stock prices when the US 10-year is below 5%. In other words, rate increases early in the hiking cycle were generally the result of improving economic expectations and still heathy inflation; further, monetary policy normalization has a good distance to go before it could be considered in any way too tight.

Interestingly, while the economy and corporate earnings still appear to be sound if not outright accelerating, some data is becoming more noisy, particularly overseas. Measures of industrial production and investor sentiment are dropping across developed Europe. US consumer sentiment was also reported to have slipped in recent weeks on rising trade fears. The monthly employment report in the US was also less robust than anticipated and those of recent memory. Soft measures of sentiment and activity such as company surveys, have also given up a little ground, at the same time as inflation data continues to suggest price levels are rising. It is true that the stock market can create its own self-fulfilling problems if a particular mood or uncertainty persists for long enough. But we also suspect the hostile political environment which includes tariff threats between major economic powers; a Russia-collusion investigation that looks to be spilling over into seemingly unrelated past personal-transgression areas for the President, and announced resignation of House speaker Ryan at the end of his current term. Add the renewed conflict between Syria, Russia and the rest of the world, and it is not hard to see why confidence might deteriorate. In fact, will it be the sorry political state of our country that is most squarely to blame whenever the current economic cycle comes to an official end?

As we enter the second-half of April, some of the most important fundamental inputs to longer-term financial market performance looks set to reinforce the most positive trends of the last 18 months. Specifically, corporate earnings season gets fully underway this week, and it is widely anticipated index earnings will be up by mid-teens over the same period a year-ago. That is exciting progress, and should allay the most acute concerns that stock prices rose too far too fast. But from an investors perspective, it is also important to try and understand what is already priced into the market. Are expectations so rosy that the bar for positive surprise is too high? Will investors fail to be impressed if companies only deliver +15-18% growth (a huge change in historical context!)? This fits with the idea that 2018 and 2019 might well be years in which the economy outperforms the market. Of additional consideration, but more challenging to invest upon, is that 2018 is another mid-term election year. At this point and with stubbornly low approval ratings, it seems likely that another major shift in the composition of Congress might be in store (Republican party loses its narrow majority). If that transpires, and the special investigation into Trump continues to cross into unexpected and seemingly unrelated areas, it is not inconceivable that talk of impeachment will further build. Markets would not like the uncertainty that such a sideshow would create in the short-run; or how much of recent actions taken might be reversed. In that vein, we suspect the elevated level of volatility presently being witnessed relative to what was enjoyed throughout 2017 is likely to persist. Long-term investors would be wise to try and condition themselves to being comfortable with feeling uncomfortable.

To quickly recap the market-moving headlines, not only did we get more definitive language around trade and investment restrictions that the Trump administration is floating against global heavyweight China, but also observed a fresh round of personnel changes that can only be interpreted by the public as ongoing stress and a volatile environment inside the White House. These do nothing to inspire investor or public confidence and the presidency continues to feel like a train wreck even to supporters of policy views. Further, Facebook which has been one of the biggest positive contributors to index performance in recent years saw its share price hammered on news that user data was used in ways the general public did not think were possible. Yet, from an economic perspective, the underlying data both in the US and abroad remains quite attractive. Last week we learned that corporate sentiment remains high, house prices are firming heading into the busier season, leading economic indicators are advancing, and durable goods orders remain healthy. Important also, early estimates for corporate earnings over the balance of this year imply strong gains and help to justify (if not cheapen) stock prices on the basis of multiples.

Despite the negative headlines about trade, and plunging stock prices that renew worries for everyday investors, we remain of the perspective based on respected macro-economic research we receive, that the economic cycle still has life. Said differently, the renewed selling pressure is more than likely part of a heathy correction; unlikely to turn into a more sinister bear market or mark the end of what is now a 9-year bull market (this is in no way intended to suggest that bull markets can run forever; we do believe we are in the latter innings of this game but extra innings are also possible). It is important to acknowledge that V-shaped corrections are rare and more often a correction is a process that involves not just an adjustment via price but also some length of time. According to market technicians, tradeable recoveries usually take the shape of a U (wherein a period of trading near the lows occurs) or a W (like appears to be developing at this time). We are also keenly watching credit spreads, which appear to be staying relatively calm during this period since late-January and imply that credit stress is not perceived to be escalating. We also believe that an all-out trade war will not develop as it is not in the interests of any country; headlines suggest that recent statements on that front are more bark-than-bite and we need to keep in context that Trump prides himself on keeping counterparties on-edge. Obviously this style leads to stress and volatile situations (and markets in this case). It is also worth pointing out that while the indexes have experienced abrupt damage, client portfolios of all objectives are holding up much better via use of active-managers who focus on owning quality companies with strong balance sheets and business models vs. those of less prideful quality. Q1 is nearing a close; but we believe 2018 extends the favorable run even if the pace enjoyed over the last two years looks certain to be more moderate and choppy and uncomfortable at times.

The employment report, the biggest economic data point refreshed last week, showed job creation of 313k during February and upward revisions to prior months. The report was collectively well better than consensus estimates of what would have still be a strong +205k; the unemployment rate held at 4.1% (the lowest reading in 17 years) and participation rose. The real story with this headline however was that the wage growth spike which accompanied the report last month was revised lower, as some economists expected due to the distortion associated with extremely cold weather keeping some hourly and labor-intensive jobs home during the month of January causing the average to skew toward higher-paid salary professions. That lower wage-growth print is significant because inflation worries have been the dominant worry for market participants in the last month. Also favorable was the latest readings on consumer confidence and manufacturing activity. Another significant development last week was previously announced imposition of steel and aluminum tariffs do not appear as sweeping as first threatened with the exemptions for Canada and Mexico. Tariffs and a trade-war sparked by retaliation are feared because, all things equal, trade friction stimulates inflation and hurts economic growth. These exceptions support the hoped-for anticipation by some that the threats are more bark than bite and will be used as a targeted negotiation tool.

Getting strong economic data without a real risk of problematic inflation has been the favorable theme referred to as Goldilocks this bull market cycle. Last month that theme appeared near death as wage growth and a host of other price-related measures all suggested inflation was dramatically accelerating. While one data point like the employment report Friday does not fully invalidate the rising inflation narrative of the past month, it goes a good way toward easing concerns that inflation was spiking at the same time the economy might be stalling. One could say the report contained the right mix of upbeat economics signaling the economy continues to expand but that the risk of the Fed short-circuiting it via anticipated gradual normalization efforts is not yet elevated. Make no mistake, the ingredients remain for inflation to creep higher, but the runaway feared in recent weeks seems overdone and the most important inputs to a still rewarding stock market (economic growth and advancing corporate earnings) appear to remain in place.

Following what was easily the sharpest and most stressful drawdown the markets experienced in the last two years, foreign and domestic equity markets are managing to fight their way back in recent weeks, dramatically narrowing the loss that was built in early-February. Volatility, remains more elevated than witnessed during virtually all of 2017 due to bond yields that have risen materially on the worry about rising inflation. But since February 9, the S&P500 is up almost +5%. With the rebound so sharp though and the pullback relatively short-lived, the biggest questions in our mind are: was that really the extent of the correction (seemed too short, even if it was panicky and nerve wracking); and secondly, will the market actually manage to finish roughly flat for the month? Writing today with the markets again notably higher, it seems the race is on, but barring a sharp selling between here and Wednesday it would seem the market has achieved a highly unexpected and HUGE moral victory and seeming credibility to participants such as us who believe the pullback was largely an overdue technical correction rather than a meaningful change to the positive underlying economic fundamentals.

From an economic perspective, we continue to observe data supportive of firmly positive economic undertones. For example, throughout the recent earnings reporting season (4Q being reported now), 78% of S&P500 companies have beaten sales estimates; that is the highest beat percentage since FactSet first began tracking this data in 2008. Other more timely indicators such as company surveys suggest the robust pace of growth remains intact if not outright accelerating. Machine tool orders surged 48% in January over year-ago, and industrial orders were up +12.4% annually in Italy; just two examples that strength appears truly global. But it is in that regard where some participants continue to be troubled and highlights our writing two weeks ago (Is Good News now Bad?): faster growth should be expected to result in rising inflation and the data continues to stoke those fears and lead many traders to worry that the Fed will need to adopt a more aggressive pace of unwinding the historically accommodative stimulus that is a hallmark of the post-financial crisis period. The topic of monetary policy itself also poses a worry for some given a new Fed Chairman and a number of seats on the committee are new faces. Are their perspectives of policy normalization different than the outgoing committee? These last two points are ground-zero for why bond yields have surged since late-January creating headaches for holders of intermediate- to long-maturity debt.

With all the emphasis and attention being paid to the robust pace of growth and how that may prove inflationary and ultimately problematic, it remains important to consider that there are still significant headwinds to sharply higher or truly problematic inflation actually materializing. The reasons are numerous, but most notably are the deflationary themes of technology, the Amazon effect, and contained oil prices. Most notably, the Amazon effect and technology continue to flood abundant and cheap and competitive pricing on a huge range of consumer goods and prices putting a lid on how much pricing power there is. Some inflation is good; actually a goal central bankers have been pursuing for most of the last 9 years. The key is, can we continue to avoid significant wage-growth that begins to pressure corporate margins (a critical input to asset prices) and leads to broader inflation, even as officially reported unemployment rates are touching all-time historical low levels. Long-term, the answer probably still remains no but there are many reasons to believe that inflation inching higher is not a problem yet. Caution: perception can become reality and if the Fed perceives problematic inflation is developing they risk over-tightening. But in our view, there still remains fuel in the tank for this cycle.

With those acknowledgements made, the pace of the pullback in the last 10 trading days is admittedly unsettling. But we cannot recall a time where a meaningful multi-day pullback was comfortable. Its never fun getting slapped around, even if one was preparing for it. What we can say with confidence is that unlike most of the pullbacks that occurred since the conclusion of the financial crisis roughly 9 years ago, this is occurring inside a fundamental backdrop that is quite strong. No economic recession ever began when corporate earnings were still rising (as they are today). This attribute is global as well not just here in US. Another early signpost for recession and the true inflection point for markets in the past is an inverted yield curve; inversion always gave investors an advance multi-month notice to be on alert. Interesting then that the yield curve has actually steeped since the beginning of the year and start of this correction and remains upward sloping. Even corporate bond yields (another historical lead to market/economic problems) are not flashing big warnings (yet; we continue to monitor). Those conditions today, combined with elevated business confidence and a just-enacted tax cut point to there being more fuel left in the tank. And, as one of the pieces we receive notes in the recent week, dips of this magnitude or even several that are larger, are not in any way abnormal inside of broader up-trends. Actually the period of 400 trading days we just enjoyed without so much as even -5% or more giveback is highly rare. That period provided a false sense of security to everyone making recent pressure feel all the more alarming in our view.

As we enter a third week since the market was enjoying seemingly no-limit to new highs, the technical attributes one might look for to identify a tradeable low seem to be developing. The market is oversold on many measures; if one measure is missing it is that so far the pullback remains short from a time perspective. Most important though is that the underlying economic fundamentals that propelled financial assets to their recent highs remain firmly in-place. This week, the economic data release calendar is full of items that will contain updates to inflation readings. Rising inflation is what is widely being credited as the spark to the recent volatility fire, so data points this week are significant. We do remain vigilant however; if technical pullbacks such as this persist too long they can risk damage to the underlying economic fundamentals and begin to change the facts. But trying to remove the emotional element and refocus on what drives returns over time, it is hard to not view the current pullback as a buying opportunity where there is new cash to be deployed. This notion has even more merit when one considers that from a valuation (price-earnings) perspective, US equities are the cheapest they have been in more than 2 years. They are especially attractive with the awareness that rising interest rates are a headwind to traditional bonds.

At the risk of sounding too confident, we the current pullback is nearing a conclusion and the bull market will resume and establish yet new all-time highs. But we are also in latter innings of this bull market (note: later innings are often the most profitable/rewarding of any), and vigilance will remain appropriate. Evidence suggests however that outright market timing is not profitable either: in the words of famed investor Peter Lynch, far more money has been lost trying to anticipate/avoid corrections (via missing out on further up-progress) than is lost in the corrections themselves.