What Your Quarterly Statements Don’t Tell You
What an incredible first half of the year! For the first six months, the S&P 500 Index was up 17.2% and the EAFE Index, which is comprised of international/non-US equities, was up 11.8%.
After raising interest rates four times in 2018, Jerome Powell, the Chairman of the Federal Reserve (the “Fed”), did an about face early in the year, indicating that the Fed would lower interest rates at least once in 2019. This provided the fuel needed to turn the U.S equity market around. Optimism quickly spread, and central banks around the world followed suit, indicating lower interest rates in an effort to stave off a global economic slowdown.
However, assessing only year-to-date or quarterly performance for 2019 makes it easy to lose perspective. The stock market does not care about quarterly statements, so we believe that providing context is part of our job. Looking back to where the market has been, beyond the current year, allows us to see more of that important context.
As the chart below illustrates, from 9/20/18 – 12/24/18, the S&P 500 Index lost nearly 20%, with the EAFE Index was down just over 16% for the same period (and nearly 20% for the year.)
When you combine these periods and assess equity markets over the last 1.5 years, U.S. and international equities have encountered some “tough sledding” (see chart below.)
This means that 2019’s strong performance was mainly recovery from 2018 losses – until recently. As you can see, as of 6/30/19, the S&P 500 Index was back to all-time highs (purple dotted line). Since then, the index has powered upward breaking above the 3,000 mark – again, largely on the back of Jerome Powell’s comments of a likely interest rate reduction at the end of this month.
Where do we go from here? What are the key things to watch going into the second half of the year?
- Corporate Earnings Corporate earnings are one of the best indicators of the health of the economy. Preliminary reports show a large number of companies have cut profit forecasts going into this quarter’s earnings season- according to Bloomberg’s data, more than 80% of S&P 500 companies have revised their profit outlook lower.
- Trade Policy Trump’s trade war with the world involves multiple battles with U.S. allies and others alike. Each battle uses a particular rationale, with Trump imposing tariffs and/or quotas on imports. Subsequent retaliation by trading partners and the prospect of further escalation risk significantly hampering trade and investment, and possibly the global economy.
- Interest Rate Policy As mentioned, in 2018, financial markets were worrying the Federal Reserve was tightening into a global and U.S. economic slowdown. As the calendar turns to mid-July, central banks are in the midst of rotating to lower interest rates, and the Federal reserve is preparing the markets for a rate cut at its July 30-31 meeting. The debate is now turning to how deep they will cut and what will follow.
Like the rallies that ended in September 2018 (and to a lesser extent, April 2019), the latest global stock market advance has produced excessive optimism, concentrated in a small group of mostly U.S. technology-related large cap stocks. We believe that this sector concentration, coupled with investor complacency, leaves equity markets vulnerable to a correction, with any unexpected bad news knocking the market off of its lofty perch. That said, we believe a correction of 5-10% would be healthy, alleviating some of the excessive optimism, and set the markets up for year-end rally.