Global stock prices climbed a wall of worry during the first half of 2019
The S&P 500 Index rose 18.5 percent on a total return basis through the first two quarters
The MSCI World ex-USA Index (a broad benchmark of international stock performance) rose 14.6 percent
- Slowing economic data, a slowdown in the rate of corporate profit growth, and rising trade frictions are the largest risks to asset prices during the second half
- Expectations for Federal Reserve interest rate cuts may be too high given current growth trends
- Investors should maintain current allocations as the third quarter gets underway
Data Source: FactSet (except where otherwise noted)
Seasonality patterns suggest further stock gains…but
In our view, U.S. stocks currently sit in the driver's seat, as strong performance in the first half sets up what historically is a solid “seasonality pattern” of continued leadership through the rest of the year. Although numerous uncertainties line the macro landscape, near all-time highs in the S&P 500 Index illustrate the optimism that carried global stock markets to their best first half performance since 1997.
Yet bonds have actually outperformed stocks over the last 12 months. The short-end of the Treasury yield curve remains inverted (shorter-term securities yielding more than longer-term securities), indicating investors are cautious about what lies ahead for the economy. Various economic trends show a softening, most notably a meaningful slowdown in global manufacturing activity in 2019. To us, this suggests a weaker demand environment. This seems to be partly the consequence of rising tensions between important trading partners.
History on our side
Despite these uncertainties, we should note that over the last 10 years, stock performance in July has been very strong. The S&P 500 Index has finished the month in positive territory 80 percent of the time, while the NASDAQ 100 Index has risen in each of the past ten Julys.
Interestingly, the strong performance in July is followed by the weakest performance of the year, on average, during August. Over the last 10 years, U.S. stocks have shed nearly one percent in the last full month of summer. After the dog days of summer finally come to a close, the rest of the year tends to see much better performance for risk assets.
Since World War II, the S&P 500 Index has, historically, gained 5 percent on average during the second half of the year on the heels of a positive first half, per the Bespoke Investment Group. When the Index is higher by 10 percent or more in the first half (like it was this year), stock prices gain another 7.5 percent on average over the second half. Importantly, seasonality trends tend to be solid over the last six months of the year, regardless of how equities performed in the first six months of the year.
If history were simply a prologue to the future, investors could pack up for the year and revisit their portfolios in January. However, we all know past performance is no guarantee of future returns. We believe slowing growth trends, and an uncertain path forward for trade negotiations, create risks investors will likely need to carefully navigate over the coming quarters.
Opportunities and risks appear balanced
As highlighted below, risks and opportunities for equity markets are fairly balanced today with a solid argument for both higher and lower stock prices ahead.
However, we believe much has to go right for risk assets to keep pressing higher in the second half, and we question the magnitude of potential gains given the softening economic backdrop. Conversely, we believe equity prices have a lot of downside risk if expectations reverse (i.e., the Fed does not cut rates more than once, growth doesn’t pick up in the second half, and the U.S. and China do not strike a trade deal).
|The Bull Case for U.S. Stocks|
- ✔Intraday trading patterns are positive
- ✔Stocks recently hit new all-time highs
- ✔Market breadth (percent of stocks gaining vs. stocks losing value) is defensive, yet solid
- ✔Investor sentiment is subdued
- ✔Seasonal tailwinds (i.e., strong first half bodes well for a strong second half)
- ✔Interest rates are low and could go lower
- ✔Lower mortgage rates could add fuel to the housing market
- ✔Financial conditions support risk assets
- ✔U.S. dollar strength is leveling off
- ✔Credit markets are on solid footing
- ✔Small businesses are confident
- ✔Expectations for economic data are low, potentially setting up for upside surprises
- ✔Valuations appear fair
- ✔An escalation in U.S./China trade tensions on hold for now
|The Bear Case for U.S. Stocks|
- ✔Expectations for Fed rate cuts this year may be too aggressive
- ✔The yield curve is inverted and re-steepening (considered a possible recession signal)
- ✔Global growth is soft
- ✔Global manufacturing activity is either moderating or declining
- ✔U.S. labor market is slowing
- ✔Earnings growth is slowing
- ✔Profit warnings are on the rise
- ✔Leading economic indicators may have peaked
- ✔Trade uncertainty remains a key headwind
- ✔Initial Public Offering volume strong, possibly indicating a rush by private investors to cash out
- ✔Political gridlock—not necessarily bullish for stocks
- ✔2020 election is right around the corner and may increase Washington uncertainty
- ✔Defensive stocks continue to demonstrate leadership
- ✔Government and corporate debt levels are high
Sources: American Enterprise Investment Services Inc. & Bespoke Investment Group
Apart from the positive seasonality setup, investors appear comfortable looking past slowing profit and economic growth, trade frictions that remain unresolved, and a Federal Reserve that is unlikely to ease interest rates to the magnitude futures are pricing in absent a recession.
In our view, investors should position portfolios with a slightly defensive bias at the start of the third quarter and lean toward higher-quality investments with more visible/predictable outlooks and earnings.
Today’s realities may challenge historical precedent
Although we recognize markets may continue to climb a wall of worry if a large disruption to growth expectations can be avoided, markets appear priced to perfection and susceptible to downside pressures if negative developments emerge.
For now, investors should consider avoiding dramatic changes to their portfolios while we await further clarity on important market drivers. Meet with your advisor to revisit the ways in which your portfolio is designed to weather uncertainty in the markets.
As of July 16, 2019
Data source: Morningstar Direct