The third quarter of 2018 was strong as far as domestic stock markets were concerned. The S&P 500 reached a record high near the end of September and finished the quarter up 7.71% and 10.56% so far this year. Strong corporate profits, waning regulatory and geopolitical concerns, and positive developments on the trade front drove markets higher. The same cannot be said for international markets, which have continued to reverse course from the strong performance recorded in 2017. Developed and emerging international markets have declined so far this year. The MSCI EAFE, a widely-followed international benchmark, was up 1.42% this quarter and down 0.99% year-to-date.
Interest rates changed little in the third quarter. The ten-year Treasury yield topped 3% earlier in the year but has drifted downward over the last several months before a more recent increase. Short-term rates continued to inch higher following ongoing rate increases from the Federal Reserve Open Market Committee this year, the latest of which occurred at their September meeting. Markets expect the Fed to hike rates one more time in December.
Markets will continue to focus on trade negotiation outcomes surrounding the United States and their trading partners. Tariffs have begun to take effect, but the short-term and long-term economic impact is yet unknown. So far, domestic markets have shrugged off any concerns and international markets have been more tentative. Escalating trade tension could derail economic progress and is a major risk to continued economic expansion. Another risk is the pace at which the Fed will continue its rate hikes. The spread between short-term and long-term interest rates has narrowed considerably, increasing the possibility that the yield curve will become inverted (long-term rates are lower than short-term rates) which many believe will signal the end of an economic cycle.
We believe the Fed will continue a moderate and measured pace of increases, and trade negotiations will not escalate into a trade war. However, we have been actively reducing risk in portfolios while maintaining a slight overweight position to stocks relative to bonds. We continue to believe inflation—not market volatility—is the prominent market risk to investors, and that stocks represent the best opportunity to build wealth and achieve investment goals over the long-term.
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