Boyd Watterson’s investment process starts with looking at the macro view of the economy. With that in mind, we expect economic growth of around 2.7% in 2018, with three Fed Fund rate increases. Additionally, while inflation is expected to move higher, it will not do so in a meaningful way in our view. As a result, our fixed income portfolios are positioned for moderately rising rates; with durations that are shorter than assigned benchmarks, and overweight spread sectors such as corporates and ABS and CMBS where appropriate. The overweight to corporates is largely driven by strong company fundamentals and fair valuations. In fact, we expect very little price appreciation compression the rest of the year and instead will rely on collecting the added yield investors receive from owning corporates to generate relative returns.
Since February, the market has focused on higher interest rates, higher inflation expectations and potential trade wars, predominately with China. As a result, volatility returned in force during the first quarter after taking the year off in 2017. However, last week kicked off the earnings season for the first quarter of 2018 and attention is being directed back to company fundamentals. Expectations are high. According to FactSet, the projected earnings growth rate for the quarter is expected to be in excess of 17% while the revenue growth rate should top 7%. So far, with only 6% of S&P 500 companies reporting through April 13, the blended earnings growth rate is 17.3% and revenue growth is 7.4%. Tax cuts and a weaker dollar have been cited as the primary reasons for the strong results. A number of the companies that reported last week were banks, who have been the beneficiaries of higher interest rates. Banks typically benefit from rising rates as they tend to quickly raise the rates they charge on loans while keeping the rates they pay on deposits low.
Over the long term, the earnings growth rate is a major driver of equity markets and corporate credit risk spreads. Investors tend to consider current results, but with an eye to the future. The good news is the remaining three quarters of 2018 also look strong. Analysts are projecting a growth rate in excess of 18% for the year, with no individual quarter expected to be below 17%. We believe the strong fundamentals will support current valuations in the corporate market and that an overweight position is warranted. Over the next few weeks we will watch as more and more companies report earnings and provide guidance to the future. It is our expectation that 2018 will be the strongest year for earnings growth in quite some time.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Senior Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC