“It is appallingly obvious that our technology exceeds our humanity.” — Albert Einstein
Second Quarter Highlights
Global equities and fixed income continued to appreciate in the second quarter, though at a more moderate pace. In a continuing reach for yield, both investment grade and the more risky high yield bonds rose. Precious metals such as gold and silver also increased, while other commodities, including copper and oil, fell during the period. The U. S. dollar rally, which began early last year, showed some signs of fatigue as the greenback fell back in late spring.
Ups and Downs Buffeted by Trade and Geopolitical Events
Following an April rally featuring a “better than feared” earnings season, markets sold off after trade tensions between the U. S. and China resurfaced. Talks broke down in early May as the Administration said China backed away from several agreed upon concessions; Beijing then refuted the claims. The two countries agreed to restart talks at the G-20 Summit in late June, but considerable damage had already been done to companies that do business in both countries.
In addition, the President threatened tariffs of 5% if Mexico did not take stronger action to stem the flow of migrants into the U. S. Fortunately, an agreement was soon worked out, though tariffs could be imposed again if the migrant situation worsens. At some point, selected trade sanctions may also be in the offing, especially with countries in the Eurozone.
Overall, global economic growth has slowed meaningfully, especially in the export-oriented countries of East Asia and Germany. Coupled with negative interest rates throughout the world, this has led to downward effect on longer maturity Treasury yields, as well as industrial commodity prices.
The situation with oil is a bit more nuanced. OPEC members and Russia, the leading non-member, agreed to extend their current output by another nine months, which should support the price of petroleum in the face of ebbing global demand. This, combined with an unraveling of the Iranian nuclear agreement, is acting as a price support for oil. Iran has threatened to retaliate militarily on oil shipping in the Persian Gulf if newly imposed U. S. sanctions are not removed. Increasingly, a reluctant Europe is being forced to choose sides as Iranian oil is being shut out of much of the world market.
Domestically, economic reports have shown weakening or moderating conditions, especially in the manufacturing sector. Housing is anemic, even with a drop in mortgage rates. Financial models used by the Federal Reserve Banks of New York and Cleveland show about a 30% chance of a recession within the next year or two. Nevertheless, other economic data is staying steady. Overall, employment remains strong with jobless claims hovering near 50 year lows. Consumer spending and confidence has moderated a bit, though both are still at high levels.
Not to Forget the Fed
The steady dovish evolution of Federal
Cruisin Reserve monetary policy continues, with Chairman Jay Powell recently testifying before Congress that “policy hasn’t been as accommodative as we had thought” due to a longer-run (neutral) policy rate assumption that has dropped to 2.5%. He also offered no pushback to the idea of a rate cut at the upcoming July FOMC meeting, referring to trade and global slowdown “uncertainty” numerous times. The question is not if, but how much of a cut to expect, along with how many cuts are coming.
Almost lost amid the Congressional testimonies were the minutes of the June FOMC meeting, which show that Fed officials know that rate cuts are expected soon by investors and lenders. The upshot is that there might be an adverse reaction in the markets with increased borrowing costs if monetary easing does not occur. It is a tacit admission that the Fed does recognize market volatility as a component in determining monetary policy.
The Outlook for the Second Half of 2019
- Given a dovish Fed along with a temporary truce in the U. S. – China trade war, continued gains in equities are dependent on a trough in the economy. Earnings estimates are sliding lower, with a pickup being pushed out to late this year. In this uncertain environment, a continued neutral asset allocation is still appropriate. If the U. S. dollar finally rolls over, it would help multinational companies, along with emerging markets.
- Ten-year Treasury yields have fallen further than anticipated, but bonds are extremely over bought and a further leg down would require much weaker economic data, especially in the U. S.
- Commodities could still be pressured with the exception of oil and gold, whose prices should be supported by geopolitical concerns, as well as very low global interest rates.