How ’Bout Them Markets!
As the second quarter progressed from April into May, it would have been completely understandable if equity investors anticipated a weak follow-through from the very strong returns generated in the prior three months. With a 12.2% return from global equities in the first quarter, a downshift would not have been unexpected. But saving the day were suggestions that trade tensions between the United States and China were potentially easing.
Additional help came from monetary policy officials and the fixed income markets, which, through a decline in bond yields, helped stocks surge higher in June with U.S. equities hitting all-time highs. With its return of 7.1%, not only did the S&P 500 have its best June since 1955, it also had its best first-half performance since 1997, registering 18.5% for the six-month period.
And with the aforementioned assist from monetary officials, the fixed income markets generated a very respectable return of 3.1% for the quarter as well as a healthy 6.1% year-to-date return. The performance of the fixed income markets may not have been as impressive as the equity markets, but the magnitude of its return was not anticipated and is reflected in the 10-year U.S. Treasury yield decline, which fell from 2.7% at the beginning of the year to a level of 2.0% at the end of the second quarter.
International equities have also participated in the strong year-to-date returns as the developed markets, measured by the MSCI EAFE Index, have returned 14.5% for the first half and emerging markets also registered a double-digit return at 10.8%.
How ’Bout That Economy!
Not to be outdone by the record-setting equity markets, the U.S. economy is also entering a never before seen phase of growth. As the third quarter begins in July, it will mark 121 consecutive months of expansion, surpassing the previous record of 120 months achieved during the period of March 1991 through March 2001.
This recovery has been characterized by modest growth, but to its credit the growth has been consistent as the economy has seen unemployment decline from levels that approached double digits during the financial crisis to the current level of 3.6%. Also, it has been accompanied by very modest levels of inflation.
U.S. GDP growth is expected to slow in the second quarter. A survey of economists conducted by Bloomberg reveals a consensus forecast of 1.8% and the most recent GDPNow outlook from the Federal Reserve Bank of Atlanta stands at 1.5%. Driving the lower growth forecast for the second quarter is a stark reduction in the private investment component of GDP, the first quarter’s strongest contributor. This decline will be offset somewhat by an increase in personal spending, but is still anticipated to be a significant drag on the overall result.
While numerous pieces of recently released economic data suggest the outlook of slower growth is warranted, we are not anticipating an imminent recession. Several factors lead us to this view. In terms of the U.S. consumer, the most recent reading of the Bloomberg Consumer Comfort Index hit its highest level in 18 years. Key components of this reading included gains in household finances and buying climate components that point to the prospect of steady consumer spending.
In contrast, the University of Michigan Index of Consumer Sentiment declined in its most recent reading. While it did decline, it is still close to the peak it hit last year and the shortfall was attributed to households within the top third of the consumers surveyed. This suggested the lower reading may have been due primarily to concerns of how a prospective increase in trade tensions could negatively impact consumers’ equity portfolios.
Also, it was widely anticipated the recently released ISM Manufacturing Index could fall below the growth/contraction demarcation line of 50. The actual reading came in at a better than expected level of 51.7, which is indicative of ongoing growth. Of course, an increase in trade tensions could lead to additional economic weakness. As previously stated, we continue to feel a recession is not on the near-term horizon.
Staying the Course
While the financial markets have delivered strong returns in the first half of the year, we continue to maintain our current asset allocation positioning. This composition includes an overweight to domestic equities, neutral weighting to international equities and an underweight to fixed income. As previously stated this allocation strategy has been very rewarding given the strength of the equity markets, particularly U.S. equity markets. We readily acknowledge volatility measures may move their equilibrium into a higher range in the second half of 2019. With the strong year-to-date performance delivered by the equity markets, investors will be sensitive to the potential for disappointment. For example, second quarter earnings reports will be scrutinized closely, not only for the prospect of earnings shortfalls but also the outlooks provided by company management that accompany the releases.
Despite the anticipation of a potential increase in volatility, our long-term focus leads us to look through the short term and place more emphasis on what we see further on the horizon.
In addition, we review our outlook for the financial markets on an ongoing basis and recognize the potential for a negative impact to the markets from an increase in trade and/or geopolitical tensions. If the inputs into our economic and market outlook indicate the need for a shift in our allocation positioning, we will make the appropriate adjustments.
As we typically do at the conclusion of these musings, we encourage investors to review their investment objectives to ensure the asset allocation currently being used truly reflects the goals, income needs and risk tolerance they want represented in their portfolio.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involved risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.