The Second Quarter in Review
Equity investors rode a rollercoaster during the second quarter. As the quarter began, global equity valuations extended their rise initiated during the first quarter. April ended and, as Jon notes in the “Economic and Market Overview” section, sentiment turned negative in May. Uncertainty relating to monetary policy, ongoing trade conflicts, concerns about sustained economic growth coupled with a slowdown in corporate profitability all weighed on equities, both in the United States and globally.
Jump forward to June and what a difference a month made as domestic large cap equities exhibited their best June since 1955. Surprisingly, not much changed in June to bolster valuations.
While first quarter gross domestic product rose a solid 3.1%, sustained economic growth in the United States and elsewhere continues to be questioned. And corporate profitability, which exhibited weakness during the first quarter, remains a concern.
That said, global equities rose 4% during the second quarter. U.S. large cap equities led equity performance rising 4.3% while small caps increased 2.3%. Foreign developed companies advanced 3.7% and emerging markets eked out a marginal gain of 0.6% for the quarter. On a style orientation basis, growth outperformed value.
Corporate profitability has been an area of contention. Specifically the scenario that forward equity valuations will be sustained by continued growth in corporate earnings within the framework of a slowing (but growing) domestic economy, coupled with ongoing angst regarding the lack of resolution pertaining to trade agreements.
According to FactSet, for all of 2019 analysts estimate earnings for U.S. large cap companies will grow 2.6% year over year (YOY). This is materially below the growth of 21.7% YOY exhibited during 2018. A similar pattern is exhibited for U.S. small cap and foreign developed companies.
In contrast, analysts remain upbeat for calendar years 2020 and 2021, with earnings projected to grow YOY by 11.4% and 11.5%, respectively. This pattern holds for developed markets outside the United States. For 2019, analysts estimate earnings growth of 2.9% YOY, with estimated growth increasing in 2020 to 7.9% YOY.
Equity valuations have trended up throughout 2019, both domestically
and outside the United States. Broad equity indexes within the United States have achieved new highs recently. One may question if this trend is expected
A recognized valuation measure is the price-to-earnings ratio (P/E) for the trailing 12 months. For the MSCI USA Index, its current P/E of 20.9x exceeds an average P/E of 19.4x over the last 10 years, which may give one pause.
However, when considering the next 12 month (or forward) P/E for this index, a different picture arises. Based on current prices and estimated earnings, the forward P/E for this index is 17.2x. One may see opportunity for higher equity valuations going forward should valuations revert to the mean (or average) and the projected growth in earnings is realized.
Given our assessment presented above regarding both forward earnings and valuation, we believe equites continue to present opportunity relative to historical valuations and also other asset classes. We expect U.S. equities will outperform foreign equities and remain biased to domestic large caps over small caps.
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.