In a nutshell, 2019 has been a bumpy ride that ultimately keeps delivering wins. By the end of the second quarter, this year’s cautious rally flourished, bolstered by a dovish Fed as well as easing tensions around the U.S. – China trade drama. Rebounding to new highs after a drop in May, the S&P 500 finished the first half of the year up 18.5%.1 Despite mixed data emerging from the housing sector and a growing disparity between the U.S. and International markets, confident consumers showed strong spending numbers. A rebound in corporate earnings generated additional optimism, as seen in the chart below, and we head into the third quarter open to opportunity.
ECONOMIC CONDITIONS UNITED STATES:
GDP: According to the third estimate released the Bureau of Economic Analysis, real gross domestic product (GDP) increased 3.1% year over year in Q1. Notably lower, the Federal Reserve Bank of Atlanta is currently running estimates 1.3%. The Institute for Supply Management Purchasing Managers Index – the prime gauge of U.S. manufacturing health – dropped markedly April, then declined to 12-month low of 52.1 in May.[2,3]
UNEMPLOYMENT: The Department of Labor reported encouraging numbers in April – 205,000 net new jobs – but saw a big drop to 90,000 net new jobs in May. Fortunately, unemployment remained at 3.6% for both months, and the U-6 jobless rate – including the underemployed – saw a decrease. The latest Nonfarm Payrolls for June registered a robust addition of 224,000 jobs.
HOUSING: Toward the end of Q2, we saw an uptick in home buying as mortgage rates went down, with The National Association of Realtors reporting a 2.5% increase of existing home sales in May. New home sales, which make up only about 10% of the U.S. residential real estate market, were down 3.7% in April and another 7.8% in May.[2,10]
The Fed was not the only central bank reconsidering monetary policy during Q2. Policymakers in Australia, Chile, India, New Zealand, and Russia all cut interest rates after May 1 in an effort to stimulate their respective economies. Globally speaking, that constituted the most easing seen since the first half of 2016. Markets in Europe benefited from comments by Mario Draghi, President of the European Central Bank, that he was prepared to loosen monetary reins in order to stimulate lethargic European Union member economies. [4,5]
In the U.K., after an acrimonious spring in Parliament that saw no progress toward ratifying a new trade pact between the United Kingdom and the European Union, the E.U. postponed the Brexit deadline until October 31. Prime Minister Theresa May announced that she would resign, and based on election results, either current U.K. foreign secretary Jeremy Hunt or prior U.K. foreign secretary Boris Johnson will replace her later this month. Johnson, widely considered the favorite, has told the media that while he does not want the U.K. to leave the E.U. without a deal, the U.K. would do well to prepare “confidently and seriously” for that possibility. [6,7]
US EQUITIES: The S&P 500 during the second quarter resembled a roller coaster. An almost 4% gain in April was followed by a 6.58% drop in May. To complete the whiplash, June saw an almost 7% climb, punctuated with a new, all-time high in intraday trading on June 21 of 2,964.03. The benchmark closed the quarter at 2,941.76. [1,11]
The Dow Jones Industrial Average settled at 26,599.96 on the last trading day of the quarter; the Nasdaq Composite, at 8,006.24.
DEVELOPED INTERNATIONAL EQUITIES: Outside of the U.S., central banks’ dovish stances as well as the continually delayed Brexit helped fuel optimism. The MSCI World Index rose 3.35%, and the benchmarks in France, Canada, and Japan as well as Euro Stoxx all saw gains. 
EMERGING MARKETS: The MSCI Emerging Markets benchmark saw a loss in the second quarter, as well as Spain’s IBEX and China’s Shanghai Composite.8,9 Individual countries fared better with Argentina’s Merval recording the largest climb of 26.02%, and Russia’s Micex also in the double digits at almost 11% up. Brazil’s Bovespa rose 6.97%.
U.S. Fixed Income: Early in June, the yield on the 10-year Treasury dipped under 2%, a development that hasn’t occurred since 2016.12,13 The U.S. Aggregate bond index gained 3.15% on the quarter as bond prices moved inversely with yields.
Developed International Fixed Income: Yields fell globally as dovish central banks followed suit. The German 10-year Bund hit historic lows, while the amount of sub-zero yielding government debt grew to a record $12.5 trillion. The Global Aggregate bond index rose 2.97% during Q2.
A QUICK & IMPORTANT LESSON IN PRICE-TO-EARNINGS RATIO
Although we saw most central banks follow the U.S.’s non-aggressive stance, only our markets surged to all-time highs. For the S&P 500, all-time highs are nudging the benchmark toward a peak in forward price-to-earnings (P/E) ratio. In its simplest terms, the P/E ratio measures how expensive the stock market is currently. Higher ratios can indicate lower value (prices are too high), high expectations (earnings growth will be robust), or both. Currently, the P/E on the S&P 500 sits near 17, above the 5-year average of 16.5 and also above the 10-year average of 14.8.
RISKS REMAIN WHILE OPPORTUNITIES PERSIST
U.S. markets rallied thanks to the dovish shift in tone from domestic and global monetary policymakers. Many investors were optimistic that the lower interest rates and greater liquidity would continue to fuel gains, despite some signs of economic weakness.
Conflicting signals from U.S. stock and bond markets continued into the second quarter this year, providing little resolution to the question of whether we are headed for a hard or soft economic landing. Overall, we view the U.S. in a late-stage economic cycle with growth curbing, but a near-term recession remains unlikely – especially with the Fed’s recent pivot.
Globally, we look to a convergence of trends. High valuations and even higher expectations in the U.S. are met with lower valuations abroad. Central banks are accommodative, and growth is stable, if not plateauing.
As the first quarter of 2019 marks the 10th anniversary of the U.S. equity bull market, investors should recalibrate their expectations to include more moderate stock prices and lower, but not necessarily negative, returns. That said, our portfolio exposure in international and emerging should benefit from any upside surprises in growth as expectations remain low.
Entering the second half of the year, we’ll be keeping an eye on the rowdy S&P 500, looking to the Fed for any signs of hawkish behavior, and monitoring the unfolding of global markets responding to a U.S. rally. Uncertain trade factors could pop up at any time, and an ever-approaching election cycle looms in the distance. But for now, we remain optimistic and ready for opportunity.
1 – money.cnn.com/data/markets/sandp/ [6/28/19]
2 – investing.com/economic-calendar/ [6/28/19]
3 – instituteforsupplymanagement.org/ISMReport/MfgROB.cfm [6/3/19]
4 – global-rates.com/interest-rates/central-banks/central-banks.aspx [6/25/19]
5 – bloomberg.com/news/articles/2019-06-27/ecb-seen-cutting-rates-in-september-as-draghi-reloads-stimulus [6/27/19]
6 – bbc.com/news/uk-politics-48497953 [6/7/19]
7 – reuters.com/article/us-britain-eu-johnson/boris-johnson-says-he-is-serious-about-no-deal-brexit-threat [6/24/19]
8 – tradingview.com/markets/indices/quotes-us/ [6/28/19]
9 – msci.com/end-of-day-data-search [6/28/19]
10 – tinyurl.com/y245hx5o [6/21/19]
11 – cnbc.com/2019/06/21/it-was-a-monumental-week-for-markets-with-major-milestones-in-stocks-bonds-gold-and-oil.html [6/21/19]
12 – wsj.com/market-data [6/28/19]
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