Market Data for the quarter ending September 30, 2018:

• S&P 500 Stock Index: 2914, up 7.2%
• Ten-year Treasury Note Yield: 3.06%, up 0.21%
• Gold: $1,196 per ounce, down 9.9%
• Crude Oil: $74 per barrel, unchanged

The third quarter witnessed the largest quarterly advance in shares since 2013, supported by a strong US economy and better than expected corporate profits. Treasury yields responded similarly to the strong growth by rising 21 basis points (0.21%) as noted above. Given higher interest rates and a perceived benign financial environment, gold continued to decline. Moving forward, we expect moderating performance in stocks, as we believe that economic and profit growth my have peaked, while the Federal Reserve and Treasury continue to tighten market liquidity. Slower growth and reduced liquidity is not an optimal environment for stocks. Furthermore, by our calculations, the stock market, as represented by the S&P 500 stock index, is at its most expensive valuation since June 2007. While valuation is not a reliable indicator of short-term market movements, the current market valuation does imply that returns will be subdued over the longer-term.

In addition to the economy and corporate profits moving past peak growth, and tightening liquidity, there are several risk factors that could curtail continued gains in shares. The new populist government in Italy threatens instability in European markets by offering a budget that will exacerbate its already precarious financial condition. Italy is heavily indebted and has a fragile banking system. The Italian government wants to expand its borrowing to finance tax cuts and increased spending, and observers worry that their financial system will not be able to digest increased Italian government borrowing. European growth has already moderated from earlier in the year, and financial stress emanating from Italy would only worsen the situation. Distress in Europe would negatively impact both American markets and the US economy, as Europe is a large trading partner of the US and has extensive financial linkages.

Speaking of trade, escalating trade tensions driven by the Trump administration will weigh on corporate confidence in the near-term and slow growth over the longer-term by increasing prices and decreasing investment. While the tariffs and counter-tariffs imposed by the US and its trading partners have yet to show up meaningfully in economic and corporate performance, it will have a long-term corrosive effect on both the US economy and markets. China, who is the principal target of US trade actions, is more vulnerable in the near-term to trade hostilities as it is more trade dependent than the US, and its economy was already slowing due to the Chinese government cracking down on domestic lending. As we have noted in earlier market analyses, the Chinese economy has been driven largely by debt fueled investment, which has left its financial system in a dangerously fragile condition. Given that China is the world’s second largest economy and heavily integrated into the global economy, Chinese weakness could reverberate around the globe and, ultimately, onto US shores.

For the remainder of the year, we expect moderating share performance due to the factors cited above. Market volatility has been running at depressed levels since the first quarter of the year, and we would expect it to increase in the tougher fundamental environment for shares we see moving forward. Additionally, the results of the mid-term elections in November could add further volatility, particularly if the Democrats were to capture both houses of Congress. In such an environment, more defensive, value oriented shares should outperform, while the expensive, momentum driven stocks that have led the market higher in recent years will come under pressure. We feel we are well positioned for such an environment. In the coming quarter we expect the stock market, as represented by the S&P 500, to trade in range of 2700 to 3000. It closed the quarter at 2914.