As we approach the mid-point of the year, we want to look at a few things that should be considered as we look towards the second half of 2018.
So far, markets have experienced increased volatility versus the average mid-term year, but we are following the same trend (with added volatility). However, the increased volatility is not as big a shock given the absurdly low volatility we enjoyed in 2017. In addition, early 2018 gave us our first market correction in nearly two years and as a result the volatility is not really that surprising.
If we continue to track roughly an average mid-term election year (see chart below), we would expect most of 2018 gains to happen in and around the second half of 2018. Here is what the current chart looks like comparing this year’s market to all mid-term election years.
This could be very welcome news as we enter the summer! The trend is still very possible (absent any major upsetting geopolitical risks).
One of the big elephants in the room is really relating to stock and bond correlations. A major test of 2018 market returns surround whether bond yields and the S&P 500 can continue to remain positively correlated. Bond yields have risen in 2018, but if the rising rates eventually spook the market causing negative correlation, we would see stocks moving lower while rates climb. So far, correlations on a rolling basis have stayed positive and not caused the market to enter a deep correction or bear market. A major theme that holds the key to the second half of 2018 is this correlation. The path forward for bonds appears to be upward. A positive correlation means that markets are likely to continue to rise as market jitters from the winter/spring 2018 correction subside.
A negative correlation could provide significant headwind to stock market advances. Therefore, we are watching the correlations very closely. Here is the most current chart showing stock/bond rolling correlations.
2018 began with a bang, fell into a swift correction, but has started to give us signs of settling. It is possible that we reach peak earnings growth, GDP growth and even a potential economic peak in the second half of 2018, but all those things will require us to remain patient and vigilant to monitor.
Economic strength leads us to believe that despite geopolitical risks, we are likely going to have a relatively normal mid-term election year. They can be filled with uncertainty, but there could still by opportunity to make gains.
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