Summary of 3Q/2018: Continuing Trade Wars and Increasing Political Uncertainty

Cheri Franklin |


The third quarter saw very healthy gains for most segments of the U.S. equity market, a decent return for international developed, and approximately breakeven for emerging markets. Despite repeated talk of rising interest rates and the 10-year Treasury breaking 3%, US Aggregate Bonds essentially broke even, but inflation-protected Treasuries (TIPS) were down a little less than 1%. Given that there were so many more up days than down days (36 and 27, respectively), it truly felt as though 2017 had returned.

As with the second quarter, it seemed that every day brought another headline of a new tariff followed by retaliation, especially with regard to China. However, the disputes with both Mexico and Canada appear to have been resolved with the announcement of the new USMCA agreement to replace NAFTA, which has been a thorn in President Trump’s side from day one.

The Federal Reserve, as expected, increased the federal funds rate to 2.25%. The 10-year Treasury yield ended the quarter at 3.05%, up 0.20% from where it began. The third quarter continued the trend of the flattening of the yield curve, as measured by the spread between 10-year and 2-year Treasuries. In other words, there is now less of a return premium for taking on term risk by buying longer maturity bonds. To be clear, this does not mean that term risk should be minimized or avoided. Nobody can say authoritatively that a 2-year Treasury yielding 2.81% is a more prudent investment than the 10-year Treasury yielding 3.05%, especially for an investor with a long-term time horizon who must consider reinvestment risk as well as interest rate risk.

The table below summarizes the estimated returns for various asset classes based on the performance of Vanguard index funds. Please note that they do not represent the returns of the funds or portfolios utilized by Clarity Capital Advisors.

Asset Class           Ticker Used          3Q/2018 Return    Year-to-Date 9/30/2018

US Total Market       VTSAX                       7.2%                          10.6%

US Large Growth     VIGAX                        8.0%                         15.5%

US Large Value       VVIAX                         7.4%                           6.2%

US Small Growth     VSGAX                      6.8%                          16.9%

US Small Value        VSIAX                        3.2%                           6.4%

International             VTMGX                     1.9%                          -1.6%

Emerging Markets    VEMAX                    -0.1%                          -8.8%

US Real Estate         VGSLX                       0.7%                           0.5%

Int’l Real Estate        VGRLX                     -1.8%                          -5.5%

US Bond Market       VBTLX                       0.1%                          -1.6%

US TIPS                     VAIPX                       -0.8%                         -0.9%


Once again, growth beat value thanks in part to the information technology sector (up 12.1% based on VITAX). Value stocks were dragged down by the financial sector (up only 3.2% based on VFAIX). In a reversal of second quarter results, one of the weaker areas of the US market was real estate investment trusts (REITs) with a 0.7% increase which is very close to their year-to-date return of 0.5%. The dollar stayed essentially constant relative to a basket of foreign currencies. The failure of emerging markets to participate in this quarter’s gains may be attributable to a decreasing ability to efficiently access U.S. markets.

Spurred by continuing tensions with Iran and Venezuela, crude oil prices ended the quarter up about 43%, creating a potential headwind to future growth. The US energy sector has not appeared to reap any benefit (up only 2.2% based on VGELX).

We continue to see signs of a US and global economy that is operating at full employment. Aside from political risk, the biggest risk to investors still appears to be unexpected inflation. For now, inflation appears to be under control with the 10-year breakeven inflation rate holding around 2%.

Regarding political risk which came into sharp focus with the contentious Kavanaugh hearings, it is worth noting that Nate Silver’s Website ( is showing an 80% probability of the House turning Democrat (33% probability for the Senate) in the upcoming November election. You may recall that among the major election forecasters, Silver came the closest to calling the outcome of the 2016 Presidential election with his prediction of a virtually even division of the Electoral College. With a divided government, we should expect no major new legislative initiatives to pass other than highly urgent infrastructure improvements. We will probably also see more temporary government shutdowns resulting from showdowns between Trump and Congress over budget issues. Gridlock is not necessarily a bad thing for investors, as the 19th Century New York politician Gideon Tucker (a Democrat) wrote, “No man’s life, liberty, or property are safe while the legislature is in session.”

The elephant in the room is fiscal policy and as Abby Joseph Cohen stated in a recent Barrons Policy Roundtable, “Current fiscal policy is a poor policy for intermediate and long-term growth.” The viability of Social Security and Medicare must also be addressed sooner rather than later.