We began the second quarter 2018 by testing the correction low set on February 9th and it held. After holding the low on April 2nd, the market made a reasonable recovery but was still not strong enough to create much follow through as it set a lower high on the charts. The technical pattern that had been established was a series of lower highs and higher lows. This creates a narrowing triangle pattern which the market has to break out of at some point. In early May we finally broke out of the downtrend and we saw some momentum come back to equities. We now are in a better market pattern of higher highs and higher lows and the S&P 500 nearly breached 2800 for the first time since March. It got within 3% of making a new high and fully recovering from the market turmoil that began in late January.
While the large company S&P500 and DJIA indices have yet to fully recover from the first quarter market correction, the Nasdaq Composite and the Russel 2000 have made new highs. Though there have been many market headwinds recently, the rise of the US Dollar and the concern over trade tariffs has caused the small cap stocks to outperform. This is due to the fact that smaller domestic companies are not affected by the rising dollar or trade tariffs to the extent that larger companies that export and/or have business overseas are. We believe it is just a matter of time before the larger companies in the S&P500 and DJIA gain traction and make new highs too.
Well, enough of the technical jargon. Fundamentals always win and the underlying fundamentals remain quite strong. Corporate earnings were nothing short of spectacular in the first quarter and are expected to continue to grow the balance of this year. With earnings growing and stocks generally at historically average valuations, based on earnings, we believe the bull market remains alive. Yes, interest rates may rise a bit but that is only because the economy is accelerating. There are some forecast for the economic output (GDP) to be 4% in the second quarter. It has been a news driven market recently though. One day the market is down due to trade tensions and the next day it is up for another reason or the perspective that an actual trade war will not happen. In our opinion, every other country needs American consumption so cooler heads will prevail in time and the intermediate and longer term outlook still looks quite compelling.
As we approach earnings season and companies begin to announce their second quarter numbers, we again expect the market to regain its focus on the fundamentals. The international trade tensions and other market moving geopolitical news will again become background noise. There are some that point to an earnings slowdown and that may be true. However, no one expected that corporate earnings could grow at the amazing pace of last year or especially the first quarter this year. When you hear concern over peak earnings, it does not mean that earnings are not continuing to grow. It just means the pace of growth may have slowed. With reasonable valuations, as long as earnings are still moving in the right direction, it should propel stocks higher over time. You do not get a bear market until you see a period of extreme excess. We would argue that we are a long way from that phase in the market.
The markets were up for the second quarter led by the small cap indices and we continue to believe the bulls will maintain control. 2018 will continue to be more volatile than the last couple of years. However, focus on the intermediate to longer term and we believe our clients will be rewarded. The short term dips will be bought and we believe this bull, though it caught a cold earlier in the year, is alive and well. Stay tuned.
