The second quarter continued the sharp upward momentum that began in the first quarter, with the S&P 500 adding 4.3% for the quarter. The strong market performance brought new all-time highs for the S&P 500 and Nasdaq. With two positive quarters in the books, the S&P 500 is up an impressive 18.5% so far this year, which is the best first half return for the index since 1997.
Despite the fact that markets have reached new all-time highs, investor sentiment has been unusually negative. Fears about trade disputes with China, geo-political risks with Iran and North Korea, and worries about recent market volatility have all played a role in dampening investor optimism. There is also a growing sense of general disbelief that the economic expansion and bull market can continue after more than 10 years. The market (once again) continues to climb the proverbial “wall of worry.”
Following pressure from President Trump to cut interest rates, the Federal Reserve has come back into center stage for investors. It has been a remarkable turnaround for the Fed over the past year. The Fed hiked interest rates in December, despite a tumbling stock market. Then in the first quarter they indicated a neutral bias, with the expectation for no changes to interest rates in 2019. More recently, they’ve indicated that they may choose to lower interest rates if economic conditions weaken. The overall effect has been interest rates generally going lower, with the 10-year U.S. Treasury yield briefly falling below 2%.
Oddly, the market has reached new highs on the back of the suggestion by the Fed that economic conditions have deteriorated enough that they may begin to lower rates again to provide support. In contrast, the market declined recently when the jobs report came in stronger than expected, thereby lowering the perceived chances that the Fed would see enough concerning signals to merit an interest rate decrease. We seem to have reentered a “bizarro world” environment where good news is bad and bad news is good.
However, as Schwab strategist Liz Ann Sonders described in a recent market bulletin, she believes that “the market has gotten ahead of the Fed.” While the market appears to have already priced in multiple rate cuts over the next year, the Fed has only indicated that they may lower interest rates if a cut is warranted. This sets up the possibility for investors to be disappointed if rates remain unchanged or are only lowered modestly later this year.
The shift in Fed expectations has been surprising because U.S. economic data continues to show considerable strength and has mostly exceeded expectations so far this year. For example, the unemployment rate was recently reported to be 3.8%, which remains well below the long-term average of 6.2%. GDP growth was 3.2% in the first quarter and is expected to be between 2-3% for the year. These are not typical conditions warranting a rate cut by the Fed.
The well-publicized trade disputes between the U.S. and its global trading partners are at the center of anxiety about the economy. According to JPMorgan strategist David Kelly, manufacturers have been preemptively building up their inventories as a hedge against possible future disruptions to their international supply chains. The eventual reduction in these inventories will logically result in a reduction in future GDP growth. In any case, the general expectation is that second half growth will likely be slower, but still positive.
Throughout this bull market (which is now more than ten years old), there has been one factor that has been fairly consistent; fear that another 2008-09 style bear market is imminent. While we don’t think there is a significant possibility for a large market decline, no one can predict the future. But as long as investors are focused on the long-term, it shouldn’t matter too much what happens in the short-term. For example, please see the chart below which shows the total return for the S&P 500 from October of 2007 (or the pre-financial crisis peak) to June of this year. As you can see it was a bumpy ride, but even money invested right at the market peak in 2007 would have earned a 148% return (or 8% per year)!
Given the long duration of the current bull market and recent bouts of volatility, investors have become increasingly anxious. While there are concerns, we believe that the U.S. economy remains on firm footing and will continue to grow for at least the next year. Under any conditions, it is important to remain well-diversified and remember that investing is a long-term proposition.
Thank you very much for your continued confidence in our service and advice. If you would like to discuss our opinions, outlook, or your portfolio in greater detail, we would be happy to schedule a meeting or a conference call at your convenience. Lastly, don’t keep us a secret. If you know someone who would like help planning for their financial future, we will be pleased to speak with them to see if we can assist.
Horizon Wealth Advisors is a Houston based fee-only wealth management firm. Horizon is a fiduciary advisor. We specialize in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.