The old Wall Street adage “sell in May and go away” seemed to be working in 2019 – until early June when the market recouped May’s decline and quickly reached all-time high levels. In fact, despite the ups and downs since the start of the year, the market registered its best first half performance since 1997. Through June, the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average returned 17%, 20%, and 14%, respectively. Granted, the year began at a low point following the Fed’s unpopular rate hike in December. This market action again illustrates how treacherous it is to make short-term “investing” decisions.
Interestingly, not much has changed fundamentally since October when stocks faltered after a long steady upward march. By and large, the majority of individual company results continue meeting or beating expectations, and the economic data are positive. Some companies are using recent dollar strength as an excuse to guide near-term expectations incrementally lower, but trade tension has eased – particularly with regard to China – which is definitely a positive. Regarding valuation, even at an all-time high the S&P 500 is trading at a very reasonable 17.5 times forward earnings, and it has only returned 8% in the past 18 months.
Until investors focus their attention on the 2020 elections, the Fed and interest rates will be closely watched. Economists are debating whether the Fed will hold rates steady or lower them, and until just weeks ago there was a significant contingent that believed the Fed’s next move would be to raise rates. That’s a wide disparity of opinions. If the Fed’s dual mandates are full employment and stable prices – which they are – then the fact that current conditions reflect both argues for no action from the Fed. We believe this is the most likely outcome for the remainder of the year. (Consensus is that the Fed will cut rates 0.25% in July.) Our opinion has been (and remains) that the overall economic strength provides an opportunity to “normalize” interest rates by staying on a moderate tightening course. Markets clearly would not appreciate any hikes at this stage, but the economy could easily absorb them.
The only argument for lowering rates is to weaken the dollar. With rates much lower in Germany and Japan, dollar strength will persist. German Bund rates are negative for 2-year, 5-year, and 10-year maturities, meaning investors are paying the government to hold their money for those periods. President Trump has been calling for Chairman Powell to lower rates for this reason. However, the anomaly is Germany’s yield curve not ours. Trump’s public appeal (via Twitter) for easier monetary policy likely (ironically) reduces the chance that it will do so. One very real risk for the markets would be the loss – or perceived loss – of Fed independence. If the Fed caves to political pressure rather than making autonomous data-driven decisions, stocks would be revalued lower to reflect a monumental paradigm shift in monetary policy-making.
Our forecast as the political cycle ramps up is for President Trump to soften his stance on interest rates and maintain his less adversarial posture on trade. Both would buoy markets, and Trump touts strength in the economy and markets as achievements of his first term. To the extent he digs in his heels on either front, we think markets would quickly show disapproval.