I. Performance Update
• The Second Quarter saw stock markets reach new highs while bond yields plumbed lows not seen since 2016. April was equities’ strongest month, after corporate earnings bettered depressed expectations, coming in about flat year over year despite initial predictions for a four percent slippage. May, on the other hand, was the worst month for investors in decades, as President Trump pulled out of trade talks with China, arguing that the world’s second largest economy had backtracked on key agreements. The US increased tariffs to 25% on a wide range of goods, threatened similar treatment on others, and labeled China smart phone maker Huawei a national security threat. Chinese counter threats ensued. Markets resumed their upward climb in June, bolstered by our Federal Reserve signaling it was prepared to cut interest rates as needed to ward off recession.
• Catching nearly all analysts off guard was the second quarter interest rate plunge, with the yield on the 10 year Treasury dropping nearly half a percentage point, ending the quarter near 2% versus the 3% or more many pundits had forecast. Although much is made of the Federal Reserve and its monetary tools, it’s new inclination to cut the Federal funds rate seems more about listening to the bond market than about showing any type of leadership.
• Small cap stocks lagged their larger brethren in Q2, not respecting the script most of Wall Street had written. Many analysts had predicted small cap outperformance, reasoning that they were much less exposed to the vicissitudes of the global economy and tariff turmoil. Now many see the fact that small caps are trailing as a sign of impending US recession. This analysis is unsatisfying as much of world overseas is already in recession, yet US large caps seemed to power through the international malaise.
• Gold finally caught a bid this quarter, advancing 8.7%. Although it’s best known as an inflation hedge and inflation has remained quiescent, the big drop in interest rates reduces its carrying costs. Speculation that dramatically lower interest rates were signaling recession also spurred demand. More monetary policy activism worldwide raises fears of future inflation, as central banks flooding the banking system with more money can create price pressures.
• Earnings continue to come in stronger than expected, with more than 75% of the companies in the S&P 500 either beating or matching analyst expectations. Earnings growth was essentially flat, but that was mainly driven from tough comparisons following last year’s tax cuts.
• The bond market surged in Q2, causing a major drop in interest rates. Occasional yield inversions, where shorter dated bonds yield more than longer dated ones, is giving rise to recession fears. The 30-year Treasury is yielding under 3% and the 10 year under 2.1%.
• The IPO market picked up once again. Many high-profile companies came to market such as: Uber, Lyft, Beyond Meat, and Crowdstrike. However, the results and investor acceptance has been mixed; Beyond Meat rose 600% but Lyft eased 10%.
• Eurozone health is on watch. Although election results continue to favor a pro EU stance, the economies of the underlying nations are struggling. Cracks in the Italian banking system continue to grow. Germany is seeing a slowdown in many of its economic data.
PREVAILING YIELDS AS OF:
II. Looking Forward
The biggest question revolves around the Fed’s interest rate policy. Will it cut rates and if so how much and when? The market is also focused on the progress of trade talks between China and the US. We remain optimistic because both countries are strongly incented to reach a deal.