As of August 20, 2019
- The United States economy grew by a 2.1% annualized rate in the second quarter.
- U.S./China trade frictions worsened.
- At the same time, 75% of S&P 500 Index companies beat second quarter earnings expectations.
- Global central banks are either easing monetary policy or preparing to do so.
- Historically, equity markets are more volatile in August and September.
- A well-diversified portfolio that emphasizes high-quality investments may be appropriate in the current and expected environment.
Data Source: FactSet
Fed rate cut offers risk and opportunity
On the last day of July, The Federal Reserve (“the Fed”) cut its federal funds target interest rate by 25 basis points (0.25%). This widely expected cut was the first in 3,878 days (or roughly 10.5 years). The chart below helps illustrate the length of that near-record stretch, which spanned the depths of the financial crisis through the longest economic expansion on record. This particular streak between rate cuts is the second-longest in history, surpassed only by the 4,115 days that passed between cuts in the federal funds rate in 1954, according to Bespoke Investment Group.
The Federal Reserve Open Market Committee cited a slowing global economy and increasing trade tensions as primary justifications for the rate cut. Importantly, the Committee left the door open for further rate cuts if either of these dynamics worsens.
Will a shift in Fed policy impact your portfolio?
With the Fed now more willing to employ accommodative measures (like cutting rates) to keep the current expansion on track, you may be asking, “What does a shift in Fed policy mean for my portfolio?”
Some points to consider:
- The U.S. economy currently stands on firm footing; the Fed did not lower rates because the economy is in desperate need of greater accommodation. Rather, the central bank provided “insurance” in the form of a rate cut to help a softening U.S. economy through a rough patch. This cut comes in light of economic difficulties in other countries, low inflation levels here at home and uncertainties surrounding global trade.
- The markets expected fixed income yields to rise this year. Instead, the reverse is playing out. Yields are falling because global central banks are focused on monetary easing (which can include cutting rates) rather than tightening (which can include raising rates), and investors in turn are clamoring for the relative safety high-quality bonds like U.S. Treasuries can offer. As a result, this could mean that your fixed income investments yield less.
- If the Fed’s read on the economy is correct and all that is required is one or two “insurance cuts” to keep domestic growth on track, then risk assets (e.g., U.S. stocks) could enjoy more upside this year. However, if the Fed determines that a series of cuts are warranted because growth keeps slowing, risk assets across the board may face a much more difficult environment.
Even still, trade and corporate profits are key
This month, the White House ramped up the pressure on Beijing and announced that starting on Sept. 1 it would impose a 10% tariff on some of the remaining $300 billion tranche in Chinese imports that have not yet felt the effect of tariffs. In response, China suspended purchases of U.S. agricultural products and started to devalue its currency versus the U.S. dollar to mitigate effects on its economy from increasing tariffs.
The bottom line is that the trade dispute has unexpectedly intensified, leaving both the U.S. and China in difficult positions. In the near term, it seems unlikely that the two sides will find common ground to de-escalate tensions.
From an equity perspective, we believe corporate earnings growth over the next 12 months is one of the most critical items to watch for stock direction. If the U.S./China trade war and slowing economic conditions worsen to the point that forward profit estimates begin to decline, we believe stocks could face significant headwinds.
Maintain a watchful eye
Unfortunately, the bond market is telling investors it believes economic growth will slow and inflation will fall still lower in the quarters ahead. Bond investors are clearly concerned that the economy is weakening. In our view, the disconnect between the still rather-optimistic stock market and now-pessimistic bond market could narrow further, depending on how the economy performs over the coming months.
How should you position your portfolio in light of this? We believe it is a time to favor quality investments, make certain that your portfolio is appropriately aligned with your desired level of risk, and ensure that your investments are positioned in a way that provides you with confidence in both up and down markets.
Talk to your financial advisor if you have questions about where you stand and how your portfolio is structured given the uncertainties of the current environment. Confirm your portfolio is structured to not only align with your goals, but to factor in the normal market swings that occur through most any market and economic cycle.
Data source: Morningstar Direct
As of Aug. 20, 2019