Summer 2019 Quarterly Commentary

To say the market has climbed a ‘wall-of-worry’ the first half of 2019 would be an understatement! Trade wars, recessionary risks, Middle East tensions to name a few. All said, stock returns were stellar and bonds rallied (rates down) significantly. The U.S. fixed income market, with its low and positive yields, remains a safe haven & the bond market-of-choice for global investors.

 

We expect significant money flows into the U.S. to continue. Hence, rates will likely remain lower-for-longer. This is very good for equities. While earnings growth estimates remain weak, we see a silver lining in the economic clouds. We are optimistic that corporate fundamentals are close to bottoming as service sector growth outpaces temporary manufacturing weakness. Bulls agree but Bears (& some bond market investors) have serious doubts. Stay tuned… tuned…

Economy Positives

Service sector to the rescue! Our service sector, which represents about 80 percent of domestic economic activity, remains the main driver of economic growth. The ISM Non-Manufacturing Index has weakened to 55.1 but is well into expansionary mode (above 50). This bodes well for second half 2019!

The Wealth Effect is alive and well. The majority of American wealth resides in the stock market and home equity. The significant decline in rates over the last six months has powered both of these consumer assets. Fed Chair Powell is well aware how it positively impacts consumer spending & economic activity.

Jobs numbers were much better than feared! June Non-Farm Payrolls were just what the doctor ordered! +224,000 new jobs were added – well above consensus estimates after a weak May report. While the 3-month average dropped to +172,000, gains were impressive, led by services & healthcare.

Economy Negatives

Uh oh! Manufacturing is flashing red!! Simmering trade tensions continue to affect the manufacturing sector. The ISM Manufacturing Index recently posted its third straight monthly decline and, at 51.7, currently hovers just above 50, below which signals contraction in the sector.

The strong dollar dilemma. The U.S. dollar’s strength has become a problem for many multinationals – especially in the manufacturing sector. The dramatic inflows of foreign capital into the U.S. have been chasing higher yields. While this is positive in the long run, short-term it remains a revenue headwind.

Will global weakness spillover? The United States is the only major country with its manufacturing sector expanding. With monetary stimulus and negative interest rates prevalent across the globe, you would think ALL countries would be expanding! This is a major red flag worrying the markets.

Financial Market Negatives

The inverted yield curve may force the Fed’s hand! Our inverted yield curve (short rates > long rates) suggests a recession is on the horizon. It is telling us that the U.S. will succumb to global economic weakness. Fed Chair Powell will likely respond with an ‘insurance’ rate cut to keep pace with other countries.

Where is the earnings growth? According to FactSet, third quarter earnings are likely to be negative for the third consecutive quarter – the first time since 2016! While the Bulls would argue 2020 comparisons will be much better, the Bears would counter the market is way ahead of itself!!

The rich, but not-too-pricey, market! The S&P 500 ended 1H’19 with a Forward Price / Earnings multiple of 17.7 – above the 25-yr average of 16.5 & towards the high end of last year’s range of 14 – 19. With rates low and recession fears potentially fading, we don’t see current valuations as unreasonable.

Financial Market Positives

The trade war truce is a huge relief! The G20 meeting did not produce a U.S. – China trade agreement but a delay in tariffs was a big positive. Significant concessions also led to a risk-on rally in the markets. However, markets will eventually need a formal agreement or some of the gains will be short-lived.

The Fed’s ‘about-face’ has driven a reversal-of-fortune. Six months ago, with the market down 19% from its highs, the thought of a market setting new daily highs mid-2019 would have been absurd. Thank you, Fed! Its change in monetary policy from hawkish (rate hikes) to dovish (lower rates) did the trick.

The global search for yield favors dividend stocks. The decline in global yields has drawn investors to dividend-paying stocks. Many names are even paying more than U.S. Treasuries! In a low-growth, low-yield world, we believe this trend may persist for some time.

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