Like 2017, the first half of 2019 saw most asset classes perform strongly as seen in the chart below.
However, the environment between these two periods could not be more different. In 2017, investors were counting on “synchronized global economic growth” and expectations of U.S. tax cuts that would lead to even faster economic growth at home. Interest rates began rising as the Federal Reserve was normalizing policy after a decade of monetary expansion. Conversely, investors today are talking about a “synchronized global economic slowdown” and decelerating U.S. economic conditions, which has led to expectations of an interest rate cut by the Federal Reserve in late July. Add to that expectations of only modest earnings growth at best for the upcoming earnings season. Trade skirmishes and tariffs also fill the headlines, and we’ve seen measures of CEO/CFO confidence measures drop from previous highs. Measures of manufacturing output have likewise declined precipitously around the world as the JP Morgan Global PMI is now below the contraction threshold of 50 after declining 17 of the past 18 months1. Bond yields have collapsed around the world as well, reflecting slowing economic growth and declining inflation expectations. There is daily talk about what today’s inverted yield curve indicates (the first inversion since 2007), as it has been a reliable leading indicator of recessions historically.
Still, most indicators of the health of the all-important U.S. consumer remain strong, driven by record-low levels of unemployment, growing wages, rising asset values, and remarkably low levels of inflation2. It’s also clear that investors have relied more on the potential upcoming monetary easing from the Federal Reserve in 2019 (along with the ECB and People’s Bank of China) than the continuing weakening economic data. In fact, following equity market declines in May of this year, equities quickly reversed course in June registering a +7.0% rally in the S&P 500 Index after dovish Fed commentary. This pushed the S&P 500 Index to the best first-half performance since 1997.3 There is also a general sense among investors that the recently reopened trade talks with China will result in an agreement that won’t further hurt global economies. At worst, markets seem to have accepted a sort of “uneasy status quo” regarding trade and tariffs, allowing other factors beyond trade to primarily drive equity markets.
Fundamentum portfolios are designed to achieve client goals through diversified holdings of stocks and bonds, both domestic and global. We are most concerned about protecting against the type of large drawdowns that occur in economic recessions and are willing to “take some chips off the table” when the risk/reward outlook deteriorates. While we currently believe a recession is not highly likely during the second half of 2019, we are not dismissive to the recession threat for the reasons mentioned earlier (especially the yield curve inversion and PMI data). To that end, we are modestly underweight equity exposure relative to our neutral points in several of our strategies presently. We’ve gotten there by reducing exposure to Developed International and Emerging Markets Equities, while remaining overweight US equities. With little value seen beyond “the belly” of the US Fixed Income curve, we remain modestly underweight duration, a stand that has detracted from relative performance in this year of surprising falling interest rates.
We continue to believe the outlook is largely balanced with risks to the downside given the large positive gains we’ve already realized this year. We do have concerns about the efficacy of any upcoming rate cuts by the Federal Reserve as well as the blind faith investors have placed in the Fed, given that the result of each subsequent stimulus measure may be diminishing. Still, we are hopeful that Fed policy combined with monetary and fiscal stimulus in China and Europe will be enough to keep global economies from slowing further. If so, given reasonable valuation levels (16.7x forward EPS for S&P 500 companies)4, earnings results may be supported and allow equities to hold their levels or to keep moving higher for the balance of the year. Until we see more evidence of this however, we will take a more cautious posture for our investors.
As always, thank you for your confidence in our team.
Fundamentum Investment Committee
Chad Roope, CFA® Portfolio Manager
Paul Danes, CFA® - Investment Committee
Trevor Forbes - Investment Committee
Matt Dunn, CFA® - Chief Compliance Officer
1-Ned Davis Research, July 2, 2019
2-Morningstar Direct, July 1, 2019
3-WSJ, July 1, 2019
4-Factset Earnings Insight, July 5, 2019
Investment advice offered through Fundamentum LLC a registered investment advisor. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the investment objective of any investment strategy will be attained. Investing involves risk including loss of principal. Past performance is no guarantee of future performance. All indices are unmanaged and may not be invested into directly.