The key themes of 2019 continue to be accommodative central banks and the seemingly daily developments surrounding trade relations between the U.S. and its partners. The U.S. economy has taken a bit of a rollercoaster ride. Some signals have suggested that the downside risks to growth are rising, necessitating further support by the Federal Reserve. Others have indicated that the economy is doing just fine, and stepping on the gas might not be warranted. The service sector has kept expanding and consumers have spent briskly. But manufacturing output fell in the first four months of the year and the housing market has remained soft. Trade concerns have clouded business certainty on investment spending and perhaps hiring plans. Consumer confidence has also been hit. The employment figures added to other data has depicted an economy that is still growing but is losing momentum after the first quarter of 2019 and last year.
The global growth backdrop has remained tepid heading into the summer. The Eurozone economy has continued to teeter on the edge, with economic growth neither fast enough to reassure officials at the European Central Bank (ECB), nor slow enough to warrant more monetary stimulus. China has faced headwinds from another escalation in the trade dispute. There has also been a rise in global political risks as the relationship between the U.S. and Iran has become increasingly strained. The oil markets could get caught in the middle.
The pace of U.S. economic growth remained at a strong 3.1% annual rate in the first three months of the year, but a downward revision to consumer spending suggested the momentum could be difficult to maintain in the second quarter. Sectors of the economy tied to trade, manufacturing and housing appeared to be struggling with uncertainties related in part to overseas trade tensions. Slowing global growth and weak inflation have also clouded the outlook for the rest of the year, prompting the Federal Reserve to signal it might cut short-term interest rates in the months ahead to give the economy a boost.
A pullback is expected in second-quarter growth with the economy expanding at a 1.5% annual rate in the April through June period. Expectations for a second-quarter slowdown are tied to factors such as the waning stimulus effects of tax cuts, government spending increases and weakening global economy. Some boosts to growth in the first three months of the year, like inventory investment and trade, could reverse. Such a slowdown, however, would not mean a recession is imminent.
In the U.S., May’s setback – the S&P 500 dropped more than 6% during the month – was driven by trade concerns as President Trump kicked off the month with tweets expressing frustration with the pace of U.S.-China trade talks and announcing a plan to raise tariffs on Chinese goods. June’s rally, producing a gain of more than 7%, benefited from optimism surrounding President Trump’s planned meeting with China’s Xi Jinping at the end-of-month G20 summit. While this meeting did not resolve trade tensions dogging the global economy, it also did not exacerbate them. Some progress was made, and the outcome appears to have met investor expectations.
In Fed news, the U.S. central bank held interest rates steady following its June two-day policy meeting. Its “dot-plot,” however, signals easier policy ahead. They have been watching closely for signs the economy might be slowing more sharply than expected amid uncertainties related to geopolitical risks or the cooling global economy.
Developed international equity returns modestly trailed those generated in the U.S., while emerging markets produced only a slight gain during the quarter. Much like the U.S., international equities suffered through a difficult month of May but enjoyed positive results in April and June. Trade-related concerns drove markets while signals from the European Central Bank of further monetary policy easing, such as new bond purchases, boosted stocks. Emerging markets were positively driven by strong quarterly results from Russia and Brazil. India produced only a small gain and China posted a loss.
Fixed income markets enjoyed a strong quarter. Government bond yields fell, driving market indexes higher. Reflecting the expectation of easy monetary policy, the 10-year Treasury yield fell more than 40 bps while the 10-year German fund dropped more than 25 bps, ending the quarter in negative territory. The 10-year U.K. gilt underperformed, falling about 17 bps for the quarter as yields rose in April on positive economic data and the announced extension to the Brexit deadline. Corporate bonds outperformed government bonds, and higher quality issues fared better than high yield. Emerging market debt produced a positive result for the quarter. Local currency emerging market debt did especially well as the U.S. dollar weakened in June.
Generally speaking, we think the second half of the year could be more difficult than the first as trade and other geopolitical issues heat up, and economic and earnings growth becomes more uncertain, resulting in possible market volatility.
In the U.S., the macro environment still looks reasonable for stocks as unemployment remains low and consumer sentiment is strong. However, late cycle dynamics, geopolitical developments, and trade-related issues may drive volatility and hinder multiple expansion. Lacking multiple expansion, any increase in equity prices will have to come from earnings growth, which is expected to only be modest in 2019 and 2020.
Early in the year, sentiment for developed international equities improved as it appeared global economic growth would soon stabilize. This positive sentiment was disrupted, however, as trade tensions escalated in May. For the remainder of 2019, lingering trade concerns will continue to dampen global business and investor sentiment. Economic and earnings growth is expected to remain subpar, multiples are likely to be capped, and volatility should continue. Longer term, however, current trade concerns do not change the international story. Growth in Europe has prospects for improvement, and Chinese stimulus along with central bank easing are positives for the Asia-Pacific outlook.
Near term caution in emerging market equities was also warranted given existing trade policy uncertainty. In the intermediate term, however, emerging markets are expected to benefit from the Chinese stimulus as well as currency appreciation relative to the U.S. dollar. Long term, emerging markets offer a rapidly growing middle class that has the potential to drive above-average economic and earnings growth.
Impacting fixed income markets, global central banks are widely expected to be accommodative in the face of deteriorating economic data. Investors who have been prepared for rising rates should consider the possibility of falling rates given the potential monetary policy changes. High quality fixed income holdings have the potential to serve as a critical portfolio ballast during late cycle periods. As the economy and earnings growth slows, bond portfolios may benefit from an emphasis on higher credit quality. High yield credit is expensive and losing cycle support.
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Based on the S&P 500 trailing twelve month Price-to-Earnings ratio, our gauge of U.S. equity valuation registers a current reading in the 21st percentile.
Based on the Federal Reserve Bank of Philadelphia’s U.S. Coincident Index, our gauge of U.S. economic activity registers a May 2019 reading in the 35th percentile.
This economic and market commentary was prepared by Capital Market Consultants, Inc. (CMC), an independent investment management consulting firm, and has been approved for distribution by GW & Wade, LLC. Data used to prepare this report by CMC are derived from a variety of sources believed to be reliable including well established information and data software providers and governmental sources. CMC is not affiliated with any of these sources.
The information provided above is general in nature and is not intended to represent specific investment or professional advice. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship.
About the indices presented above:
- Standard & Poor's 500 (S&P 500®) Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.
- The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq.
- The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
- The MSCI ACWI (All Country World Index) is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world.
- The MSCI EAFE Index is an equity index which captures large and mid cap representation across Developed Markets countries around the world, excluding the US and Canada.
- The MSCI Emerging Markets Index (EM) captures large and mid cap representation across 24 Emerging Markets (EM) countries.
- The Bloomberg Barclays Global Aggregate Bond Index measures global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
- The Bloomberg Barclays US Aggregate Bond Index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States – including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year.
- The Bloomberg Barclays US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.
- The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. GW & Wade assumes no duty to update any of the information presented above.
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