Summary of 2Q/2019: Continuing Trade Tensions and an Interest Rate Drop
The second quarter turned in another solid performance on top of a very strong first quarter. The top-performing segment of the US equity market was large growth (once again driven by technology which was up 5.4% for the quarter and 27.2% year-to-date, based on VITAX). Although it’s not over yet, this decade is shaping up to be a reversal of the “lost decade” of the 2000s where the S&P 500 Index underperformed small cap and value segments of the US market as well as the foreign equity markets.
There is an old saying that a bull market climbs a wall of worry, and there was certainly plenty to worry about during the second quarter. Once again, trade tensions with China heated up, culminating in the levying of $200 billion in tariffs against Chinese goods followed by $60 billion of retaliation by China. With the recent G-20 Summit, there appears to have been a ratchet downward. Tensions in the Middle East flared up with the announcement of sanctions against Iran after the US withdrawal from the Iran Nuclear Agreement. Iran responded by shooting down a US drone, and President Trump chose not to retaliate due to an estimated high number of casualties. Interestingly, crude oil prices barely moved for the quarter.
Based on the futures markets, investors now fully expect the Federal Reserve to move from a restrictive to an accommodative monetary policy. Investors now assign an 87% probability to at least a half-percent cut to the Federal Funds Rate by year-end. It is important to remember that the Fed, more often than not, is a follower (of the bond market) rather than a leader in setting interest rates. During the quarter, interest rates across all maturities dropped by 0.3 to 0.5%. As a result, bonds showed a strong quarterly performance, but they now have lower expected future returns. Some observers claim that the bond market is “sending a recession signal”. The equity markets, however, are clearly marching to a different drummer. An important story that we will be watching closely for the third quarter is the attainment of the Treasury debt ceiling limit. Gridlock does not even begin to describe the current relationship between Congress and the White House. If there is indeed a default on US Treasury bonds, it is not yet clear which party will bear the brunt of the blame.
International developed markets had a decent quarter, but emerging markets (dragged down by China) disappointed. US Real estate also turned in a good quarter, partly explained by the interest rate drop.
The table below summarizes the estimated returns for various asset classes based on the performance of Vanguard index funds. Please note that they do not represent the returns of the funds or portfolios utilized by Clarity Capital Advisors.
Asset Class Ticker Used 2Q/2019 Return YTD 6/30/2019 Return
US Total Market VTSAX 4.1% 18.7%
US Large Growth VIGAX 4.8% 22.4%
US Large Value VVIAX 3.8% 14.9%
US Small Growth VSGAX 3.8% 24.1%
US Small Value VSIAX 2.0% 15.6%
US Real Estate VGSLX 1.7% 19.3%
International VTMGX 3.3% 13.8%
Emerging Markets VEMAX 0.7% 12.1%
US Bond Market VBTLX 3.1% 6.1%
US TIPS VAIPX 2.8% 6.1%
The US economy still appears to be operating at full employment. With the 10-year breakeven inflation rate now holding around 2%, unexpected inflation appears to be less of a concern.
According to the Wall Street Journal, 2019 was the best first half-year for US equities since 1997. In our opinion, the best way to think about the financial markets is that every day going forward has the same expected return, and as long as markets are functioning normally, it is positive. Once again, our advice, as always, is to be invested and stay invested at an appropriate risk level, and by appropriate, we mean an asset allocation to meet your goals that you will hold through all different types of markets.
We wish all of our clients and retirement plan participants a Happy Fourth of July.