Investors had to stomach a bout of turbulence in the second quarter as economic uncertainty increased compared to the first three months of 2019. Underlying fundamentals for the economy and the markets remain generally solid, and investors are now anticipating the first Fed rate cut in over a decade. An extended “truce” in the U.S.-China trade conflict— should further support the stock market. So, while we should prepare ourselves for more historically typical volatility, the outlook for markets remains generally positive as we begin the second half of the year.
In sharp contrast to the quiet, steady gains of the first quarter, stock market performance in the second quarter was one marked by extremes. April was a good month thanks to better-than-feared first quarter corporate earnings reports. Additionally, investors’ expectations for a 2019 Fed interest rate cut rose in April, which added fuel to the bullish fire. The S&P 500 ended April near new all-time highs.
Fears and volatility returned in the first week of May, however, as President Trump announced that he would be raising tariffs on $200 billion in Chinese goods from 10% to 25% following the collapse of U.S.-China trade negotiations. Furthermore, The President threatened to levy additional tariffs on the remaining $325 billion worth of Chinese products imported into the United States.
The news caught investors by surprise as reports previously implied a U.S.-China trade deal was close to being finalized. Stocks dropped sharply in reaction. Those of you who attended our webinar in early April would likely remember that one of our concerns were that investors were perhaps overly-confident about the prospect of a trade deal being reached, in spite of statements from trade officials that there was still much work to be done before either party would sign on the dotted line.
Further escalating the U.S.-China trade conflict was the decision by the Commerce Department to add the Chinese telecom company Huawei to its “Entity List,” which would effectively ban U.S. companies from doing business with the telecom giant. That development caused stocks to fall further.
The stock market was able to find support and rebound strongly in June. There was progress across the two main sources of volatility in the second quarter, trade and interest rate policy. First, at the June 19th meeting, the Federal Reserve reversed course from May and signaled an interest rate cut is likely in 2019, perhaps as early as July. Second, President Trump and Chinese President Xi Jinping agreed to meet at the recently held G20 meeting, and the result of the meeting was a trade “truce” of no new tariffs while trade negotiations resume.
Third Quarter Market Outlook
The markets were impressively resilient in the second quarter and registered gains despite deterioration in global economic activity and renewed uncertainty with U.S.-China trade. Our years of experience have taught us not to become complacent just because markets have been resilient. We think that’s again appropriate as we start the second half of the year.
As we start the third quarter, we face macroeconomic uncertainty on multiple fronts.
First, the U.S.-China trade situation remains delicate, and until there is clarity, that lack of clarity will act as a headwind on economic growth and likely create periods of turbulence.
Second, global economic growth metrics underwhelmed in the second quarter. The impact on global stocks was muted by rising expectations of more stimulus from global central banks, including the Fed.
Third, there remain several unsettled geopolitical situations that must be monitored, including Brexit (the deadline is October 31st), North Korea (relations are still unsettled despite the recent Trump/Kim meeting) and Iran (the chances of a U.S.-Iran military conflict are as high as they’ve been in years).
Finally, while the Federal Reserve has signaled it will begin to reduce interest rates in the coming months, the situation remains very fluid, and if the Fed does not meet market expectations by cutting rates, that will cause short-term volatility. In our opinion, the market’s expectations of the Fed and the potential for disappointment appear to be the biggest potential risk facing the current market.
It remains unclear how, or when, these events will be resolved, and what those implications will be for markets. Yet as 2019 has shown us so far, uncertainty is not, by itself, enough to offset the still-strong fundamentals in the U.S. economy and corporate America.
As always, please call with any questions or concerns or to set up a time to review your current allocation. Thank you for your continued confidence and trust.
Don, Darren & Audra.