Quarterly Market Review and Outlook
Q2 2019 Economic / Market Re-cap
The 2nd Quarter continued the upward trend for financial markets in 2019. In fact, the U.S. stock market has hit an all-time high this year.i Non-U.S. stock markets, also, have produced solid returns and are up 13.6% during the first six months of 2019.ii
The U.S. and foreign bond markets are both up over 6% year-to-date.iii
All in all, the global financial markets have been on fire.
Q3 2019 & Beyond Outlook
Interest Rate & Federal Reserve Update
In the U.S., many people assume that the President controls the economy. Certainly, the President plays a major role. We would suggest, however, that the real power to control the U.S. economy on a day-to-day basis does not reside at 1600 Pennsylvania Avenue. Rather, that power can be found at 20th Street and Constitution Avenue—the address for Jerome Powell and the Federal Reserve Bank.
Many times over the last several years, markets have placed a heavy emphasis on the Federal Reserve’s actions and words. In the latest example, Chairman Powell’s speech on June 4th provided hints of the Federal Reserve’s willingness to cut interest rates at their July meeting.iv His remarks calmed some nerves (at least in the short-term) and the S&P 500 index gained almost 7% in June.v That is power. It is because of this power and influence that we often talk at length about interest rates, the Federal Reserve, and the role they play in the U.S. economy.
There is currently a 100% probability of a .25% interest rate cut later in July based upon Fed Funds Futures.vi We aren’t sure we agree with the logic or the necessity behind this.
It will probably provide some investors with a feeling of security in the short-term. It may even cause some fears over trade wars to slightly diminish. We would argue that a rate cut potentially weakens the Federal Reserve’s power when real economic turmoil hits. The Federal Reserve should consider using their considerable power to act during crisis, not because they feel political pressure or that a few media outlets are selling hysteria.
As we wrote in our last Newsletter, we have recently been close to an inversion of the interest rate yield curve. Given its history of preceding previous recessions, we feel like this is something we should closely monitor. The Fed’s decision on short term rates obviously impacts this significantly.
Global Stock Market Conditions
Late last year and earlier this year, some money managers and economists began stoking fears of an imminent recession because of Trump tariffs, slowing economic data, and an inverted yield curve. Taken together, surely the sun was about to explode! While the 4th Quarter last year and May of 2019 were pretty tough, the current economic expansion is the longest in our history.vii
Is the end near after such a long run?
First, we’d provide our standard disclosure that we don’t own a foolproof crystal ball. With that out of the way, as we review and interpret economic and market data, we continue to see little to suggest that an economic recession is imminent. The third estimate of 1st Quarter 2019 GDP was published in late June and confirmed the previous readings that the U.S. economy grew at a 3.0%+ clip from January to March.viii The current projections for the 2nd Quarter (we will get the initial readings on July 26th), suggest the U.S. economy expanded at an annual rate of 1.5%.ix
In addition, consumers have jobs x, are seeing wage increases xi, and are spending.xii As consumer spending accounts for more than 2/3’s of the U.S. economy, it is difficult to see how the economy suddenly crashes if people have jobs, their incomes are increasing and they are spending money.xiii While some of this can be a bit of trailing data, it still provides us with confidence that the U.S. consumer is in solid shape.
If there are a few red and yellow flags related to the U.S. economy, they would be on the production and manufacturing side of the economy. We want to be careful in that there is little to nothing showing contraction, but rather a slowing in pace.xiv Again, this would support our argument that the economy may not be growing at the pace in 2017 and 2018, but this horse is not ready to be put down just yet.
Finally, after the returns in June, most markets are at or near all-time highs. This does not mean markets are due for a correction, but just a friendly reminder that nothing goes up forever. We would expect volatility to persist throughout the year. As we have previously stated, unless something changes in our analysis of the data, we would consider market pullbacks as a buying opportunity not a reason to run for the hills.
Global Economic Environment / Trade Dispute Update
The biggest news item from the 2nd Quarter related to the global economy was the ongoing trade dispute between the U.S. and China. As we mentioned in our previous newsletter, we view the long-term prospects of a deal to be higher than an all-out trade war. The theory is simple, an all-out trade war ultimately benefits no one.
It is certainly possible that an all-out trade war could slow the global economy to a recession. If you are President Trump, do you think that your chances of reelection increase in the midst of a recession next year? From our perspective, President Trump has sufficient motivation to make sure this doesn’t escalate to all-out trade war status.
From the Chinese perspective, they are already seeing signs of businesses relocating to other countries (i.e., Vietnam, Cambodia, Myanmar, etc.) in order to dodge tariffs and maintain cheap labor.xv The impetus for China’s emergence several decades ago was cheap labor. The Chinese now have competition for cheap labor due to higher exporting costs that has the potential to derail their economy.
What tariffs have provided is the mainstream media a sounding board for doom and gloom. So far, it seems like most of it has been without merit. We expect the U.S. will be on the winning side of this and will emerge with a better deal than when we started.
Nothing is ever going to be perfect. Certainly, there are areas of the U.S. and the global economy that appear to be slowing. We would continue to beat the drum, however, that the foundation is solid. Just last week, non-farm payrolls destroyed expectations on payroll increases for June by adding 224,000 jobs (the consensus expectation was an addition of only 160,000 jobs).xvi Historically, the economy does not collapse when jobs are being added at this rate. Likewise, historically, the stock market does not crash when the economy is this solid.
We would also caution against extreme optimism. The stock market has put on a strong performance YTD and nothing goes straight up forever. We expect some volatility in the near term before the next push higher.
Thank you for your continued confidence and business. As always, we continue to monitor events, data and projections. Should anything change in our thinking, we will take the necessary and appropriate actions.
We hope that you have a great Summer!
vii Wesbury, Brian S. & Stein, Robert. “The Longest Expansion.” Morning Monday Outlook. First Trust Advisors, L.P. July 1, 2019.
viii Bureau of Economic Analysis. “Gross Domestic Product, First Quarter 2019 (Third Estimate); Corporate Profits, First Quarter 2019 (Revised Estimate).” June 27, 2019.
xiv Cahill, Kristina. “June 2019 Manufacturing ISM Report on Business.” Institute for Supply Management. July 1, 2019.
xv Zhou, Joyce & Wang, Ann. “To Dodge Trade War, Chinese Exporters Shift Production to Low-Costs Nations”. www.reuters.com. June 26, 2019.
xvi Wesbury, Brian S. & Stein, Robert. “Nonfarm Payrolls Rose 224,000 in June”. First Trust. July 5, 2019.
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Walker, Higgins & Associates, LLC and Walker, Higgins & Associates Wealth Management, LLC are independent of First Heartland Capital ®, Inc. and First Heartland ® Consultants, Inc.