Market Update July 17, 2019
Stocks and bonds continued their ascent in the second quarter of 2019, fueled by the expectation that the Federal Reserve will begin cutting interest rates at their meeting on July 31st. While expectations have softened from a .50% cut to a .25% cut, the financial markets are pleased the Fed has become accommodating, a sharp reversal from where they stood late last year.
Domestic stocks as measured by the Standard & Poor’s 500 were up 18.5% through the first six months of the year. Medium and small company stocks have not fared as well, but are still up in the teens. Established foreign economy stocks as measured by the MSCI EAFE index were up 14.0% while emerging market stocks as measured by the MSCI Emerging Markets index were up 10.6%. Bonds, too, benefitted from the easing in monetary policy, with the Bloomberg Barclays U.S. Intermediate Government/Credit index up 5.0%. Across the board, it was a great six months.
After such a strong first half – and with the S&P 500 nudging to new all-time highs – investors may be tempted to cash in their chips and go to the sidelines. Dramatic shifts in investment strategy such as this tend to be a poor idea. While my enthusiasm is a little tempered for stocks at this point, they remain a more attractively valued long-term asset class than bonds, especially following the sharp drop in bond yields over the past eight months. Also, it is largely just the U.S. large cap growth stocks that are at lofty levels, driven in part by the popularity of S&P 500 index funds. The outperformance of growth stocks versus value has continued, resulting in many stocks having very reasonable valuations and attractive dividend yields.
So what will it take for stocks to continue to rise? Besides a resolution to the U.S./China trade dispute, I believe rising earnings will be necessary to justify a further increase in prices. Earnings for the S&P 500 are projected to rise only in the low single digits over the next two quarters. Stock buybacks by corporations flush with cash have been a meaningful contributor to stock market performance due to their impact on a company’s reported earnings. As companies buy back stock, they reduce the total number of shares outstanding. When the share count goes down, the earnings per share (EPS) goes up because the companies' earnings are spread over fewer shares. As the EPS goes up, the stock becomes more valuable to shareholders. While stock buybacks are not quite at the blistering pace they were last year following the reduction of the corporate tax rate, they remain very high. Ideally, companies would have rising revenues to grow their profits, which broadly speaking will require continued economic growth.
With unemployment in our country being incredibly low and our economy seemingly on solid footing, one might wonder why the Federal Reserve is expected to cut interest rates later this month. After all, the Federal Reserve’s principal objectives are to maximize employment and stabilize prices (meaning to keep inflation from becoming too fast or too slow). Mission accomplished. However, the role of the Federal Reserve has greatly expanded over the years, with the Fed now taking a more active approach to stabilize the economy in other ways. The Fed has joined forces with other central banks around the world in unprecedented fashion over the past twelve years, initially in response to the global financial crisis of 2008. The Fed is not leaning towards cutting rates simply to boost economic growth. Manufacturing growth around the world has stalled, in no small part due to trade wars and Brexit (Britain’s attempt to extricate itself from the European Union). Many global companies are hesitant to invest not knowing what the playing field is. Until these trade agreements and Brexit conditions get resolved, I believe economic growth potential is likely to be restrained. By lowering interest rates, the Fed is attempting to compensate for the negative impact of trade agreement uncertainty through looser monetary policy. Other central banks are expected to follow suit. As I mentioned, the Fed’s role has expanded greatly beyond maximizing employment and moderating inflation.
I hope you are having a wonderful summer. Do not hesitate to reach out to me if you have any questions or anything I might be able to help you with.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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· The S&P 500 is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. The MSCI EAFE index and the MSCI Emerging Markets index are unmanaged indexes compiled by Morgan Stanley Capital International that are generally considered representative of the developed international stock market and emerging international stock market, respectively. International securities involve additional risks including currency fluctuations, differing financial accounting standards, and possible political and economic volatility, and may not be suitable for all investors. Investing in emerging markets can be riskier than investing in well-established foreign markets. The Bloomberg Barclays Capital U.S. Intermediate Government/Credit Bond Index measures the performance of U.S. Dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year and less than ten years. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
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