For investors, the volatility of the last 18 months has been especially frustrating. Like Sisyphus endlessly pushing his boulder to the top of the hill, only to watch it tumble down again, we have seen the stock market reach a new peak three times, only to drop back sharply. Yet, looking at just the first six months of 2019, this has been a good year overall for stocks and indeed all asset classes, even bonds.
Large company stocks, as measured by the S&P 500, are up 18.5% for the first half of the year, albeit rising off a relative low at the end of 2018. Small cap stocks have also performed well, with the Russell 2000 up 17% year-to-date. May’s sell-off of 6.6% was not nearly as sharp as the 20% fourth quarter plunge in 2018, or the 10% drop earlier in that year. The drop-off in May reflected concerns over trade tensions with China; when those eased in June the market recovered to score all-time highs, just above levels seen in January 2018, September 2018 and early May 2019.
Bonds have also done well in the first half of 2019. The Federal Reserve is now expected to lower short-term interest rates in 2019, reversing course after a series of quarter-point increases which began in late 2015 and which took the Fed Funds target rate from approximately zero to the current target range of 2.25% to 2.50%. At the end of June the Barclays US Aggregate Bond Index was up 6.11% for the year. If that return holds through year end, it would rank as the best year for the major bond index since 2011.
|Market Index Returns as of June 30, 2019|
|Index||2nd Quarter||YTD||1 Year||3 Years||5 Years||10 Years|
|S&P 500 (US Large Cap)||4.3%||18.5%||10.4%||14.2%||10.7%||14.7%|
|Russell Midcap (US Mid Cap)||4.1%||21.4%||7.8%||12.2%||8.6%||15.2%|
|Russell 2000 (US Small Cap)||2.1%||17.0%||-3.3%||12.3%||7.1%||13.5%|
|MSCI ACWI X-US IMI Net (Foreign Equity)||2.7%||13.3%||0.3%||9.2%||2.3%||6.8%|
|MSCI EM (Foreign Emerging)||0.6%||10.6%||1.2%||10.7%||2.5%||5.8%|
|Barclays Aggregate Bond||3.1%||6.1%||7.9%||2.3%||3.0%||3.9%|
|Barclays Muni Bond||2.1%||5.1%||6.7%||2.6%||3.6%||4.7%|
|Past performance is not an indication of future performance.|
The current bull market was ten years old in March, and we are now also celebrating the tenth anniversary since the end of the last recession. As of this month, this current expansion is tied with 1991-2001 for the title of the longest enjoyed by the US in the last 75 years (see chart below). However, even though the current expansion will soon be the longest in recent history, the expansion lags behind most others in terms of the rate of growth, with just 2.3% annual GDP growth. This slower rate of growth may explain why we haven’t seen the types of excessive risk taking by investors typically seen at the end of a bull market.
Several factors support continuing economic growth. Most estimates for 2019 GDP growth range from 2% to 3%, in line with annual growth over the past decade. US unemployment has continued falling and is currently at a very low 3.6%, boosting consumer optimism. Despite the lowest unemployment rate since 1969, wage growth has remained subdued. There are pockets of the labor market that are seeing pay increases but overall, managers aren’t yet being forced to pay more to hire workers. We typically see wages rise over 4% year-over-year as the economy overheats late in the market cycle. June’s robust job creation figure of 224,000 further signals economic health.
Furthermore, trade issues that sparked May’s selloff have calmed for now, with a temporary trade truce in place with China as talks continue. The US is postponing tariffs on an additional $300 billion in Chinese imports.
Moreover, the Federal Reserve, which helped propel stocks higher in June by signaling a possible future rate cut, seems to be standing ready to support the economy with further rate cuts if it deems it necessary. Though it’s hard to understand why the Fed would lower rates if the economy were not in immediate danger of recession, one guess is that the Fed governors saw the market’s negative reaction to its December rate hike as a misstep they do not want to repeat.
On the other hand, periods of economic expansion do not go on forever, and there are several factors to keep an eye on. Trade issues are not going away any time soon. It is hard to envision a permanent trade deal while China competes to overtake the US as the premier global superpower. While China relies on the US to buy its goods, there is a limit to how heavy-handed the US can be in its negotiations.
Meanwhile, manufacturing is slowing around the globe. The Purchasing Managers Index (PMI), which indicates manufacturing trends for national economies, is showing that manufacturing outputs for most major economies are now in, or approaching, the contraction zone (see chart below).
In Europe, Brexit remains an ongoing puzzle with no happy resolution in sight. British officials appear to be increasingly likely not to reach a deal before the UK’s official exit from the European Union. Failure to reach a deal would mean border checks would be introduced, transport of people and goods would be disrupted, and EU tariffs would be introduced. The deadline for the official Brexit is now scheduled for October.
Meanwhile, here in the US, the micro-economics of individual companies are beginning to reveal internal pressures on margins. Top line revenue growth appears scarce for many companies due to the weaker global economy and the uncertainty created by the trade war. 2019 earnings growth will likely be meager compared to the outstanding numbers posted in 2018. Juiced by the 2017 tax cuts, S&P 500 earnings grew by more than 20% in 2018. The comparisons will be trickier in 2019. This brings into question the sustainability of indefinite rosy market expectations. One sign that stock market sentiment is still quite high is the number of high-profile IPOs of Silicon Valley “unicorns” such as Uber, Lyft and Pinterest—companies that have grown to $1 billion+ valuations. A significant earnings recession will let some of the air out of the balloon…hopefully this can be avoided.
Volatility appears set to continue. Treasury bond yields once again inverted in the second quarter, with the ten-year bond paying less interest than the three-month bill—frequently an indication of a coming economic slow-down. We live in a world where a 140-character tweet can send the market up or down by 2%. It’s easy to imagine the negative event that could push us lower—military conflict with Iran, trade interruptions with China, a terrorist act. Positive events could also surprise us, with a positive effect.
We are navigating through a challenging time for investing. We’ve faced uncertainty over the past several years and investors have been rewarded for patience. With the economy on stable footing, we’ll continue to use these short-term bouts of volatility as rebalancing opportunities to buy at lower prices or take profits on price jumps. Through these actions, we hope to be well prepared for whatever lies ahead.