Second Quarter 2019
Life in the Fast Lane
In the second quarter, most asset classes have received the message: “Be positive!” Like the first quarter, the asset classes we generally use for our investors were positive. The gains were not as significant as the first quarter, but they were substantial.
The S&P 500, for example, ended the first quarter at 2834 while the second quarter result was at 2942. This increase of 108 points equates to an additional 4.2% gain for the year. The S&P 500, having begun the year at 2507 is now up 17.3% for the year. Not to be left behind, the S&P Mid Cap index went from 1896 to 1946, up 3%. From the beginning of the first quarter, when the index began at 1663, to the end of the second quarter, this index went up 17%. While large and mid-sized stocks did well, small cap stocks, as measured by the S&P Small Cap 600 index, didn’t do quite as well. They ended the first quarter up 11.2% and the second quarter up 12.8%. This rise from 939 to 953, or 14 points, only contributed to a 1.6% gain for the second quarter.
While domestic investments were doing very well, the international equity market was also improving. The DJ Global ex U.S. index rose from 244 to 248, a gain of 4 points or 1.9% for the quarter. Adding to the first quarter results, this index is now up 11.4% for the year. This is a major improvement over 2018.
Once again, bond interest continued the downward trend. This is short-term good news for investors, because, when bond interest rates drop, the value of bonds climb, along with the actual interest earned. The 10-year Treasury Bond went from 2.416% to 2.0%, which is significant. The Bloomberg Barclays US Aggregate Bond Index also fell, from a yield of 2.93%, at the end of the first quarter, to 2.49% at the end of the second quarter.
At the end of the first quarter, the Fed had indicated that it was unlikely to increase the discount rate this year. In an announcement earlier this month, the Fed Chairman indicated that it was likely the Fed would reduce the discount rate at the end of July. This gave the markets a boost.
While April and May lagged and saw a reduction, economic output rebounded in June. Production was up, workers’ earnings rose, and consumer spending increased. Inflation has remained in check, with almost all methods of calculating inflation showing it to be at or below Fed desired levels. The concern for me is that if the Fed lowers the discount rate now, they will reduce their ability to help the economy if we get a serious downturn in the future. In addition, if the Fed discount rate is reduced and the economy is doing well, then the economy could heat up, which would not be good. The Fed is in a tight spot, because most of the data that is used in determining the discount rate will not be available at the time that they will be making their decision.
The U.S. economy appears to be doing amazingly well with virtually full employment and high consumer confidence. Some of the world’s economies seem to be faltering. The Fed should not be trying to shore up foreign economies, which might be why they cut the discount rate at the end of this month. This has not worked in the past and likely would not work now.
Each country controls its own economy. A communist country like China is controlled centrally by the government. With a curtailment of exports and having high national debt, China appears to be in trouble.
The socialistic nature of many European nations tends to reduce the willingness to take risk while the tax burden on the population, to provide social services, is high. Add to this tight monetary policy and you can understand Europe’s dilemma.
Some third world countries, such as Vietnam and Indonesia, are being helped, with the shift of manufacturing out of China and into their countries. This is occurring, in large measure, because of the tariffs imposed by the U.S. on Chinese goods.
The U.S. economy is still very strong. Even with the added increase in S&P 500 index stock prices, the forward price earning ratio has only moved from 17.03 to 17.72. At the same time, the dividend yield has fallen from 1.96% to 1.91%, which I don’t see as too bad. Overall, U.S. stocks and bonds look fairly priced. We expect that a number of companies are going to miss earnings targets for the second quarter but, as mentioned earlier, a major improvement took place in June. A reduction in the Fed discount rate is now built into the markets. If the Fed decides not to lower the rate, we will likely see a negative reaction from the markets.
Posted July 24, 2019