Economic Commentary | Second Quarter 2019

The stock market experienced quite a roller coaster ride during the Second Quarter of 2019, with many of the same stories from the First Quarter carrying over into the spring months. Global events rather than domestic developments dominated the market’s attention, including the evolving US-China trade war, the slowing worldwide economy, and uncertainty surrounding global central banks’ monetary policy. For the quarter, the large cap S&P 500 index rose 4.3%, the mid/small cap Russell 2000 index gained 2.1%, the international MSCI EAFE index grew 3.7%, and the emerging markets MSCI EM declined by 0.3%.

We saw a sharply higher market in April on optimism over a US-China trade deal taking shape while the Fed began to shift from a restrictive policy to a neutral stance. US GDP grew by 3.1% for the prior quarter, a marked improvement over the 2.2% gain seen in the Fourth Quarter of 2018. The GDP report highlighted strength in consumer spending along with muted inflation pressures. China’s First Quarter GDP matched the prior quarter’s growth of 6.4%, which was welcome news to those that feared slowing growth in China. Treasury Secretary Steven Mnuchin provided some reassurance to global markets at the end of April when he stated that trade talks between the two countries were “getting into the final laps.” Another boost to sentiment came in the form of a four-month extension of the deadline for the UK to grapple with Brexit and reach a deal with the European Union. As a result of these positive developments, the S&P 500 logged four new all-time highs in the last week of April.

May unfortunately erased April’s gains ~ and then some ~ as investors focused on renewed angst over the US-China trade war. Though a deal seemed imminent at the end of April, President Trump became frustrated by the slow pace of talks along with a perceived retreat in China’s end of the bargain. At the end of the first week in May, Trump threatened to raise existing tariffs on $200B of imports while enacting new tariffs on $325B of Chinese goods. China then retaliated with its own tariff hikes, quickly escalating the tough talk on both sides. In addition to trade worries hanging over the market, rising geopolitical tensions evolved in the Middle East, as the refusal by the US to grant sanctions waivers to Iran’s energy customers resulted in Iran’s oil exports dropping 90%, crippling their already-struggling economy. In response, Iran abandoned the 2015 nuclear deal and engaged in military operations to put pressure on Europe to broker a deal with the US. As the situation escalated, Trump declared a national emergency and sent troops to the region.

By early June, the ongoing trade war with China prompted Fed Chair Jay Powell to make the case that a rate cut by the Fed would be under consideration should a deal remain elusive. The market rallied in response, with improvement in sentiment also coming on the heels of a disappointing jobs report which boosted expectations of a Fed rate cut sooner rather than later. Powell’s public statements during the month of June made it clear that the Fed would act “as appropriate” to sustain the economic expansion despite the ongoing trade fight with China. The market responded positively to each comment by Powell, with one more all-time high reached by the S&P 500 index toward the end of June. Tensions with Iran continued to build, as the US came to the brink of military action just before Trump aborted an intended strike. By the end of June, the US and Iran were engaged in a war of words, which was ~ at least ~ preferable to military action in a very complicated and dangerous part of the world.

Just after the last trading day of the quarter, Trump and Xi Jinping met at the G20 gathering in Japan. Early reports were optimistic that a deal was near, as the US agreed to scale back restrictions on Huawei while China agreed to significantly increase their purchases of US agricultural products.

The US economy continues to be a pillar of strength in an increasingly complex and interconnected world. Despite much global uncertainty, consumer and business confidence in the US has remained remarkably resilient. While growth in the manufacturing and service sectors has slowed from recent highs, both sectors continue to expand, as measured by the twin Institute of Supply Management reports. Corporate earnings have come in above expectations, albeit lowered expectations, with 76% of the S&P 500 companies beating analysts’ expectations last quarter. While job gains increased at a more modest pace than recent quarters, with an average 161K jobs created each month, this was impacted by the relatively weak report for May. That said, we were pleased to see that the June report (received after the end of the quarter) showed an impressive bounce back to 224K new jobs created. During the quarter, housing reports were mixed as affordability continues to be impacted by a shortage of land and skilled workers. Nevertheless, the data on permits and housing starts, which are considered leading indicators, bode well for housing to continue to boost economic growth in the US.

As always, we remain focused on achieving long-term value creation by engaging with our managers who are committed to a carefully concentrated strategy, low turnover, and tax efficiency. While we expect to underperform when the market is surging (as it has this year, with an eye-popping return of 18.5% for the first half of 2019), our managers’ approach offers downside protection should some of the current geopolitical risks become more amplified. It is this conservative approach that comforts us as the US economic expansion set a record in July at 121 months, which has coincided with the longest bull market ever.