Financial Markets – A Recap Of The First half 2019

 Executive Summary

The S&P 500 index produced a return of 17.35% in the first half of 2019, its best first half since 1997. June also marks the 121^st month of the current economic expansion making this the longest economic expansion in U.S. History. However, increasing concerns about slowing global economic growth (including the U.S.) and increased risks due to trade tariffs resulted in deteriorating macro-economic conditions in the first half of 2019. As a result, the U.S. Federal Reserve signaled it is open to cutting interest rates to stimulate growth and sustain the current economic expansion. In short, 2019 has been a very good year but some signs point to a possible slowing of growth. We continue to maintain our long-standing view that timing the market is extremely difficult and that remaining fully invested in a diversified portfolio is the best course of action. The past 3 quarters have been prime examples: The S&P 500 declined 13.52% in the 4th quarter of 2018 and then rallied 17.35% in the 1st half of 2019.

U.S. Federal Reserve

• At its June meeting, the U.S. Federal Reserve Chairman, Jerome Powell, announced that the committee would keep the U.S. federal funds rate target range steady at 2.25-2.50%. However, the Federal Reserve provided a strong indication that it is open to cutting interest rates in order to sustain the current economic expansion.
• A significant number of the committee members now favor an interest rate cut of 50bps before year end. Seven members now see 50bps of rate cuts in 2019, one sees a 25bps rate cut, and eight members see interest rates on hold. That's a significant shift from the March FOMC meeting where eleven members saw rates on hold this year.

Yield Curve

• The inversion of the U.S. yield curve is a topic that the financial media continues to highlight to investors. Historically, a negative yield curve implies investors expect future short-term rates to be lower as the Federal Reserve eases policy in response to a potential recession. According to J.P. Morgan Research, 7 out of the 8 U.S. yield curve inversions since 1960 were followed by a recession.
• While the media has been focusing on the 3-month Treasury bill vs. 10-year Treasury inverted yield curve, not all parts of the U.S. interest rate yield curve are inverted. For instance, the 2-year vs. 10-year spread remains positive at 24.82bps as of June 28, 2019. In fact, the 2-year vs. 10-year spread has historically been more of a bellwether for predicting economic recessions and has been steadily steepening since the 4^th quarter of 2018.
• The NY Federal Reserve Bank maintains a Recession Probability Index for the next 12 months. As of May 31, 2019, the NY Federal Reserve’s Recession Probability Index for 2020 stands at 29.62% (see chart below).

• Global Economy

  • The G20 summit took place on June 28, 2019. The U.S. administration announced that it will pause tariffs on 25% of the remaining $300 billion U.S. imports from China. China announced that it would continue to purchase agricultural products from the U.S. Moreover, both countries announced it will roll back some non-tariff barriers such as restrictions on high-tech exports by U.S. companies.
  • Global economic data has deteriorated in 2019. The J.P. Morgan Global Manufacturing Purchase Managers Index, which is a measure of economic health for the manufacturing and service sector, has steadily declined since early 2018. A slowdown in various economies globally along with trade concerns have been the key drivers behind the weakness in manufacturing data.
  • The U.S. economy isn’t immune to the global growth slowdown. The Atlanta Fed GDPNow Forecast Model is 1.50% as of June 28, 2019. On August 1, 2018, this model was forecasting GDP to be 4.95%.

• Morgan Stanley’s Business Conditions Index recently had its largest one-month decline since 2002 and is near its 2008 Great Financial Crisis level (see chart below).

  • U.S. stock valuations are neither cheap nor expensive. According to FactSet Research Systems, the S&P 500 Index forward P/E ratio is 16.6x as of June 28, 2019, and is slightly above the 5-year average (16.5x) and the 10-year average (14.8x).

• International Equities

  • On the back of the U.S. Federal Reserve’s more accommodative stance in 2019, International Developed and Emerging Markets equities posted strong returns in the 1^st half of 2019. The Shanghai Stock Exchange Composite Index (China) increased by 20.96% (in CNY terms), the Euro STOXX 50 Index (Europe) rose by 19.81% (in Euro terms), the MSCI Emerging Markets Index was up 11.06% (in USD terms), and the Nikkei 225 Index (Japan) increased by 7.53% (in Japanese Yen terms).
  • Source: Bloomberg.
  • According to ETFAction.com, the iShares MSCI ACWI ex U.S. ETF (ACWX) currently has a P/E ratio of 13.60x based on 2019 analyst estimates. This is significantly lower than the SPDR S&P 500 ETF (SPY) which has a P/E ratio of 17.47x based on 2019 analyst estimates.

• Fixed Income

  • U.S. interest rates declined across various maturities in the 1^st quarter. Yields on the 2-year, 10-year, and 30-year U.S. Treasury Bonds were 1.75%, 2.01%, and 2.53% respectively as of June 28, 2019.
  • The Bloomberg Barclays U.S. Aggregate Bond Index is up 6.11% as of the end of the 1^st half. We continue to prefer owning higher quality U.S. bonds across our portfolios. We maintain an overweight position in U.S. municipal bonds and U.S. mortgage-backed securities, both of which are highly rated. In fact, over 80% of our fixed income bonds are rated either AAA or AA.