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Market Commentary — 2nd Quarter 2018

The second quarter played out as almost a perfect mirror image of the first quarter. Where the first quarter started out strong and then faded into March, the second quarter began very weakly but ended on a high note. Early in the quarter, markets declined as fears of inflation and trade wars with China and Europe dimmed the economic outlook. As the quarter rolled along, however, economic reports continued to strengthen, and investors began to believe that trade war rhetoric was much more bark than bite. As a result, the equity markets began to rally, and the S&P 500 closed the quarter with a healthy gain of 3.4%. Smaller companies clearly outperformed during the quarter as the Russell 2000 gained 7.8%, while the Dow Jones posted a much smaller gain of 1.3%. For the first half of the year, the S&P 500 is now up 2.6% while the Russell 2000 improved by 7.7%. On the other hand, the Dow Jones is still down by 0.7%. This likely reflects the fact that trade disruptions will fall harder on larger companies.

Rhetoric from the White House regarding increased tariffs for Chinese and other imported goods continued early in the quarter and spooked equity markets. While some viewed this as a blunt negotiating tactic aimed at improving our trade agreements with other countries, the consistency and forcefulness of the message coming from the President sent a message of a looming trade war. Thus far the White House has not backed down on its threats, lending credence to the likelihood of an extended trading disruption. We tend to believe that this is all part of a negotiation, but we are well aware of the negative market implications should a trade war develop.

Rhetoric from the White House regarding increased tariffs for Chinese and other imported goods continued early in the quarter and spooked equity markets. While some viewed this as a blunt negotiating tactic aimed at improving our trade agreements with other countries, the consistency and forcefulness of the message coming from the President sent a message of a looming trade war. Thus far the White House has not backed down on its threats, lending credence to the likelihood of an extended trading disruption. We tend to believe that this is all part of a negotiation, but we are well aware of the negative market implications should a trade war develop.

Despite the trade fears encompassing markets, economic growth continues to surprise on the upside. Based on the strength of economic releases, GDP is expected to exceed 4% in the second quarter (release is on July 27), and many believe that strong growth will continue throughout the year. As we expected, the tax cuts have had a much stronger impact on the economy than many had initially forecast. In addition to the growth effects from the repatriation of billions of dollars, the after-tax hurdle rate for capital projects was essentially reduced by one-third. This has resulted in a significant jump in expenditures to fund growth initiatives, which helps lead to an improvement in employment, wages, and economic growth. In addition, long-term interest rates remain low, which further reduces the cost of capital. Many believed that as the Federal Reserve increased short-term rates, long-term rates would follow suit. To date we have not seen this rise in rates, and interest rates remain at historical lows. This is likely due to continued absence of inflation in the economy and the fact that interest rates in other countries such as Japan and Germany are negative or very close to zero. As a result, demand for bonds in the United States remains robust and helps to keep rates down. We expect this trend to continue for the foreseeable future or at least until we begin to see a real rise in inflation.

As you can probably see from the tone of this letter, our equity market outlook remains positive. We are aware of several risks, both geopolitical and trade-related, that could undermine this forecast, but by and large, fiscal and monetary policy initiatives provide a solid backdrop for continued economic growth. We are slowly getting accustomed to the heightened level of market volatility brought about by the unprecedented level of rhetoric, threats and commentary coming out of the White House, and in fact, in many cases we are attempting to take advantage of the short-term market swings. Despite the volatility, equity valuations continue to march higher.

On a personal note, as you may or may not know, May 27, 2013 marked the 25th anniversary of the founding of Doheny Asset Management. We would like to extend a heartfelt thank you to all of our clients, many of whom have been with us since the beginning, for trusting us with the stewardship of your capital. Our success is a direct result of your trust in us, and for that we are truly grateful.

Market Commentary 2nd Quarter 2018

Market Commentary 1st Quarter 2018

Market Commentary 4th Quarter 2017

Market Commentary 3rd Quarter 2017