As in times past, most notably the mid-1980s and 1990s, the Fed has been able to prolong economic expansions by cutting interest rates, and that is what they are likely to attempt in 2019-2020. Having maintained the bulk of our equity exposure, we were able to participate in the equity rally so far, and we remain optimistic for portfolio returns through the end of the year.
US Economy: Need for stimulus?
The US economy officially entered its longest expansion in history as GDP growth (3.1% in Q1) continued for the 121st consecutive month. Deteriorating manufacturing and trade data, in the US and globally, raise legitimate questions about how much further growth can run without further monetary or fiscal stimulus.
US Stocks: Fed support cheered.
Investors who didn’t “sell in May” were rewarded with strong equity returns as both US large and small-cap stocks hit record highs or close to it. Confidence that the Federal Reserve will cut interest rates at least once in the second half of 2019 let investors rationalize higher valuations for higher-risk assets.
Foreign Stocks: Muted rally vs. US.
Europe minus the UK performed well (+7.4%), as renewed optimism about US-China trade talks boosted the markets of their major trading partners, and a small decline in the US dollar (-1%) also aided performance. Meanwhile, weak economic data from Japan (+3.7%) was a headwind.
Fixed Income: Big drop in T-bond yields.
Bond prices gained, as longer-term interest rates continued to fall, with the 10-year US Treasury yield falling to 2%, about even with 3-month Treasury bills. Year-to-date, the yield on Treasuries have dropped as inflation hasn’t picked up and expectations for Fed policy have shifted dramatically — from interest rate hikes to likely cuts.
Real Assets: Infrastructure, commodities lead.
Infrastructure stocks matched the high-octane performance of global equities and are the best performing sub-asset class so far in 2019. Gold led commodities, gaining nearly 10% in the last two months as investors have sought out its perceived safety amid global trade uncertainty and geopolitical tensions.
Alternatives: Hedge funds OK performers.
Alternative strategies were generally positive for the month of June, with the notable exception of merger arbitrage (-0.3%). Macro strategies (+3.1%) were among the strongest performers, benefiting as most financial markets presented broad trends.
Equities Total Return
|U.S. Large Cap||7.0%||18.5%||10.4%|
|U.S. Small Cap||7.1%||17.0%||(3.3%)|
Fixed Income Total Return
|U.S. Agg. Bond||1.3%||6.1%||7.9%|
|U.S. High Yield||2.6%||10.4%||7.8%|
|Munis Broad Mkt||0.4%||5.4%||6.7%|
Non-Traditional Assets Total Return
|Overall HF Market||1.6%||4.2%||(2.0%)|
|Gold Spot $/OZ||$1409||$1282||$1253|
|U.S. Dollar Index||91.6||92.0||89.7|
The Federal Reserve is in a quandary. The US economy seems neither too weak nor too strong but comments from Fed Chair Jerome Powell have led investors to believe with a high degree of certainty that rate cuts are coming. In this, the Fed is acknowledging that the US economy isn’t as healthy as it appears on the surface and could use a little help. However, as in times past, most notably the mid-1980s and 1990s, the Fed has been able to prolong economic expansions by cutting interest rates, and that is what they are likely to attempt in 2019 and 2020.
Will that work? Based on how the financial markets have moved in the last several weeks, investors are saying the answer is yes. As we have said previously, lower interest rates could provide an added boost to several drivers of the US economy including real estate and consumer spending. However, if the Fed fails to deliver on these expectations, the goodwill built up in June could easily fade and then some.
We are grateful to have maintained the bulk of our equity exposure, which allowed us to participate in the equity rally so far this year. And we remain optimistic for portfolio returns through the end of the year. That said, if the Fed fails to follow through on its “promises,” we are well-positioned to take advantage of the resulting market turbulence.