Started From the Bottom, Now We’re Here
On June 20, the US stock market closed at a new all-time high, breaking through 2,950 on the S&P 500, and ending the most significant drawdown of the decade.
The prior high was set exactly nine months ago to the day, on September 20. Since then, we’ve seen a near 20% correction in US equity prices that bottomed on Christmas Eve. Domestic equities are up 17% year-to-date.
Fixed income investors should be equally pleased. Interest rates have steadily fallen throughout the year, boosting performance for existing bondholders. After starting the year at 2.7%, the yield on the US 10-Year Treasury note finished out June all the way down at 2%.
Our Perspective
This year’s steady recovery has been supported by the lessening of several key risks. Investors have grown comfortable with the risks overhanging the market, including the direction of monetary policy, trade war, and other geopolitical turmoil.
We believe investors are far too complacent over the risks facing markets today. Additionally, we have become incrementally more concerned with the trajectory of global growth, which we expect will revert back to its prior low growth state.
In this kind of economic environment, investor expectations should be lower. We do believe, however, that the current market remains highly advantageous to active managers with the flexibility and conviction to be selective and nimble.
The Fed is Singing a Different Tune
For the past several years, the Fed has worked hard to ‘normalize’ monetary policy by raising interest rates and reducing the size of its balance sheet. This effort, which was unofficially put on hold in January, may be coming to an end.
Falling interest, inflation, and growth rates are concerning Fed policymakers and sparking potential action. Market expectations for the next Fed meeting indicate that a policy rate cut is now a near certainty.
Our Perspective
The Fed has good reason to unwind some of its policy ‘normalization.’ Inflation has remained below target for quite a while now, and global growth appears to be slowing.
Many investors associate interest rate cuts with an imminent recession. We think the issue is more nuanced and believe that stock market rallies can continue with lower interest rates. Either way, implications for fixed income investors are vast and necessitate a hands on approach.
For more, see our recent blog post, The Fed Has Its Work ‘Cut’ Out.
US and China Agree to Disagree
Meeting at the G20 summit over the final weekend of June, President Trump and Chinese President Xi Jinping appeared to break the ice in the ongoing trade standoff. The two world leaders agreed to a “temporary cease-fire” on additional tariffs, while leaving in place existing measures. Currently, the US has imposed a 25% import tax on nearly half of all Chinese imports.
Our Perspective
While US-China trade tensions remain front and center, not all trade-related developments have been bad. President Trump backed off his Mexican tariff threats, and he also gave a reprieve to Europe and Japan on auto tariffs. Still, trade remains a key risk that must be monitored as a legitimate trade war would be a major shock to the global economy.
| Our View | ||
| Economic Cycle |  | The future for global economic growth has become increasingly uncertain; the world economy appears to be reverting to a slow growth pace; for now, global demand remains supported by lower inflation, falling oil prices, lower interest rates, and a healthy labor market |
| Stock Market | | Stocks remain near highs in the aggregate and seem to be ignoring several rising risks to growth and earnings; we expect longer run equity returns to be low absent a significant change in the geopolitical environment |
| Bond Market |  | Falling interest rates and inflation have led the market to begin to anticipate multiple Fed rate cuts over the next 12-18 months; the yield curve is now the most inverted to the policy rate since the last recession; credit spreads remain relatively tight |
| Foreign Exchange | | Stronger US growth and higher US interest rates vs. the rest of the world have helped the US dollar remain strong; we view the dollar as a critical monitoring point going forward |
| Important Issues on the Radar | | Trade Tensions: an escalation remains a high impact risk to the entire global economy, and any further worsening of relations may negatively impact business and investor sentiment China Growth: ongoing stimulus efforts are doing just enough to support growth; economy remains soft Italy: policy uncertainty will rise and remain elevated given ongoing discussions around Italy’s debt and deficit situation Brexit: following the resignation of PM Theresa May, the current front-runner, Boris Johnson, is campaigning to take the UK out of the EU without a deal; this uncertainty will pressure the UK economy, UK stocks, and the Pound currency over the next few months at least |
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