Investment Review for Second Quarter 2019

Risky asset roller coaster.

The second quarter was a bit of a roller coaster for risky assets. Early on, domestic, foreign-developed, and emerging market stocks all rose during the month of April. The trend did not last however, as a sell-off took hold during the month of May causing sweeping losses. The financial markets shifted once more in June, with risky assets rising in value.

By quarter-end, the positive days outweighed the negative for stocks, alternative strategies, real estate, and infrastructure. Only commodities were left with a slight loss. 

When combined with the first quarter, risky assets across the board were positive for the first half of 2019, many with double digit gains.

Major asset class returns.

Trade war escalation.

Much of the financial market stress that occurred during the month of May can be attributed to an escalation in trade tensions, most notably with China. 

• The first escalation came on Monday, May 5 when the President announced that the 10% tariff on $200 billion of Chinese goods would be raised to 25% in just five days.
• On May 10, he stated there was “absolutely no need to rush” to complete a trade deal, alerting the financial markets that the negotiating process may take much longer than expected.
• On May 30, he shifted his focus to Mexico and threatened tariffs on all Mexican goods, unless the country ramped up efforts to stem the flow of illegal immigration at the southern border. Fortunately for financial markets, the Mexican standoff was resolved within a few short days.

More stimulus, please.

With trade tensions high and concerns about slowing global economic growth, the financial markets once again looked to the central banks of the world for help. It was this assumption that help was on the way, that assisted financial markets in June. Help in the form of lower interest rates. 

To be precise, the financial markets have now priced in a 100% chance of at least a 0.25% cut in interest rates by year end. In fact, financial markets believe an even greater cut is quite likely, pricing in an 87% chance of a 0.50% rate cut.

Remember that the financial markets love low interest rates. Lower interest rates mean cheaper borrowing costs for home buyers, car buyers, and businesses.

Global interest rates.

Market expectations for future interest rate cuts can also be seen evolving over time when examining the interest rate on 10-year treasury bonds. That rate has fallen from a high of 3.2% last November to the 2.0% level seen on June 30. 

Although 2.0% is quite low compared to historic measures, it is quite lofty for a developed country today. Currently, the European and Japanese central banks continue to hold short-term interest rates near zero. Investors in Europe and Asia, who are expecting additional stimulus from central banks, have pushed the interest rate on 10-year government bonds below zero in many countries.

While there are only a handful of countries with negative yielding debt, it has added up quickly. The world had $13 trillion of debt with below zero yields at the end of June.

Corporate profits.

Large U.S. corporations have benefited from the current economic expansion and have grown both sales and profits well above the inflation rate since 2010. Sales growth has increased steadily at an annualized rate of 4.2%. Profit growth has been a bit more volatile but has averaged 6.9% during the same time period. 

Much of the profit gain, however, was concentrated in the past few years. This can be attributed to one major factor: tax relief. Effective tax rates fell from 27.9% in the first quarter of 2016 to 13.2% in the 4th quarter of 2018. That is a 52.3% drop in just a few years. 

As such, with no additional tax cuts on the horizon, it is unlikely that corporations will be able to continue to grow profits at the pace they have over the past few years.