Review of 2nd Quarter
After two sluggish months in April and May, the stock market had an outstanding June,making for a profitable quarter for investors. U.S. stocks rose by 4% for the quarter and are now up 19% for the year. Developed international stocks also did well, rising by 4% for the quarter and 14% since the beginning of the year. Emerging stocks only increased in value by 1% for the quarter and are now up 11% for 2019. Bonds enjoyed a return of 3% for the quarter and 6% for the year.*
State of U.S. Economy
Below is a table showing key economic and market indicators (as of June 30)**:
Consistency is good for capital markets. The continued strength of the economic data (low inflation and interest rates, declining unemployment) has been a steady drumbeat during the 2010s, and that evenness has certainly aided the capital market performance.
There have been two factors that have been impacting the daily movement of stock prices –trade policy and the potential of an interest rate cut by the Federal Reserve. The reduction in trade tensions with China and Mexico in particular, and the expectation that the Fed will reduce rates, are the main reasons why stocks did so well in June. However, while those factors will likely continue to impact stock prices going forward, causing some continued volatility, those impacts will likely be both positive and negative, and over the long-termwill not be a driver of stock returns.
What will be a driver of market valuations is the growth in profitability of U.S. companies,which, as we mentioned in last quarter’s outlook, has been truly remarkable. Continued growth in profitability will mean continued growth in stock prices -- based on current estimates for 2020, growth in profits from 2016-2020 will be 15% per year.*** The causes of such increased profitability – mainly improved efficiency based on technology – are not likely to subside.
What can go wrong? For the first time in a while, we will use the R word – recession. There are signs of a slowdown in economic growth in China, and European growth has been lagging the U.S. One reason the market has been so reactive to trade policy is the potential impact on worldwide growth. It’s highly unlikely that the U.S. economy would be immune to a global recession, and the potential of such a recession can’t be dismissed. While we don’t see a U.S. recession as being probable over the next couple of years, we still must consider the risk of a potential recession on market valuations.
Over the past six months we’ve gone from an environment in which the broad expectation is that the Federal Reserve would likely increase rates (as they had been doing the past two years) to one in which the expectation is they will cut rates. While those reversals have happened in the past, they typically have occurred because of signs of weakness in U.S. economic data, such as a drop in GDP or employment. We are living in unusual times. This reversal in policy explains the outstanding bond market performance.
It’s been a great half of 2019. While we remain optimistic for the future, we also see the potential of a decline, and believe that balance in a portfolio is the best way to approach an uncertain future.
* Source of returns is Morningstar, Inc. Past performance is not indicative of future results.
** Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, JP Morgan, Federal Reserve Board
*** Source: S&P Dow Jones Indices