Investment markets in the second quarter, while still volatile, delivered less of a “roller coaster” ride than during the first quarter of the year.  The best performing asset class was Real Estate Investment Trusts (REIT’s), which climbed 7.8%.  US Stocks, as measured by the S&P 500, were up 2.9% (although this gain was due almost exclusively to big technology stocks).  Other major markets struggled, however.  International Stocks sank 4.2% … while broadly diversified fixed income markets lost roughly 1%, with rising interest rates reducing bond valuations slightly more than the offset of income produced by those bonds.  The overall effect on investment portfolio performance was lackluster, in most cases resulting in very modest gains.

Two major themes dominated the investment landscape during the second quarter, and they are very likely to do the same for the third quarter (and possibly the remainder of 2018).  Global economic activity remained healthy, with the US outperforming most other major developed economies.  Robust corporate profits remain the fundamental driver contributing to the positive performance of domestic stock markets.  And although the Federal Reserve continued its program of raising short-term interest rates, the Fed’s gradual pace and ability to effectively communicate its intentions has allowed markets to absorb the impact of higher rates with relatively little damage.

On the downside, investment markets have been focused on the increasing possibility of a global trade war.  The imposition of trade barriers served as the defining global economic development of the second quarter.  The US applied tariffs against China, as well as traditional European and Canadian allies, inviting retaliatory tariffs in response.  If the threat is carried out of further tariffs being imposed on a broad range of international trading categories, global economic activity inevitably will suffer.

A trade war will lead to higher prices for consumers.  It also will hurt the bottom line of companies that sell imported goods and depend on global supply chains in their production process.  In a “worst case” scenario a global trade war, if unchecked, could hasten the end of this business cycle and usher in recession.

Most alarming, the stoking of trade war tensions threatens the very foundation of the system that has supported the global economy since the end of World War II.  Although the actual trade actions to date have been relatively modest, in our view the rising possibility of more widespread tariffs looms as the biggest risk to investment portfolios for the remainder of the year.

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