US Market Viewpoints: Second Quarter 2019Submitted by Castlebar Asset Management on July 2nd, 2019
The market once again hit fresh all-time highs this quarter. Stocks saw large swings in trading with April and June being big winners while May saw a 6.5% decline. The S&P 500 had its best first half of the year since 1997 and the Dow saw its best first six-month performance since 1999. The change in stance from the Federal Reserve (Fed) served as a catalyst to lift the market. The Fed has indicated they are open to cutting interest rates this year which is typically supportive for stocks. US – China trade talks appear to be getting back on track. This also helped lift stocks during the quarter. The trade war and tariffs are starting to hit companies on both their profits as well as their future business planning. The one overriding theme is headlines drove performance this quarter as much as fundamental data.
While all markets posted solid gains in the quarter, large-cap stocks (+4.3%) continue to beat smaller companies (+2.1%). This trend has been in place for some time and is usually positive for the market. When small-cap stocks outpace large-cap it is usually seen during market peaks. The best performing sectors were financials (+7.4%), materials (+5.4%) and technology (+5.4). Financials rallied on the back of insurance companies which surged 11.6% in the quarter. Materials benefited from a strong performance in gold. The yellow metal rallied 9.2%. Technology shares gained as investors continue to seek out growth-oriented names. Energy shares sold off about 3.6% in the quarter. Oil prices dove lower during most of the quarter which weighed on the group. Energy stocks were off by more than 14%, but did see a pretty strong comeback after two oil tankers were attacked in the Strait of Hormuz in June.
Over the past several quarters, we have started to construct our stock portfolio and our ETFs portfolios to position you in the event of a market sell-off. One of the things we have done is purchase ETFs that focus on low volatility companies. This strategy was put in place to help provide a cushion in a down market and was a defensive move. We are pleased that lower volatility stocks have done quite well this year. They have outperformed the broader market year to date. Low volatility indexes have focused on financials, utilities and real estate which all have benefited from a drop in interest rates.
Initial Public Offerings (IPO) have had a robust 2019. IPOs are when a company sells stock to the public for the first time. Over $30 billion has been raised in new issues this year with most coming in the technology sector. The average opening day gain has been 34%. There have been some high-profile successes like Beyond Meat (+540%) and Zoom Video (+146%). Not all IPOs has been runaway hits. Uber and Lyft, both ride-sharing companies, are two of the larger IPOs this year. Both companies struggled out of the gate and have only managed single-digit gains so far. When the IPO market is hot, I immediately get nostalgic for 1999 and 2000. This was the last IPO boom when near $90 billion of new companies came public in each of those years. It was also the source of a bubble. The companies going public today are more mature than those from the late 1990s. The companies which have IPOed this year have been in business for an average of 12 years while the average was only four years back in 1999-2000. The one trend still in place is most companies coming to market are not profitable. This is fairly normal. A healthy IPO market is usually the sign of a maturing economic cycle and not the sign of a market top or a bubble.
Our outlook for stocks remains positive. We expect the rest of the year to look similar to this quarter, in that, the market will be choppy but still trend higher. Market valuations (forward P/E of 16.7x) are slightly above historical averages (16.1x 25 year average) but we remain in a low inflation environment. This is conducive for price to earnings and other valuations to stay above average. There are two things that are in focus for investors; The Fed and the trade war. The Fed is expected to cut rates several times in the second half of the year. Their first chance will be in July. Interest rate cuts will be supportive for stocks in the near term. Historically, when the Fed cuts rates in non-recession period stocks have rallied significantly over the next three to twelve months. In eight instances when this occurred stocks rallied 15% over the next quarter and over 24% during the next year.
The trade war and tariffs are starting to impact both confidence and corporate profits. CEOs of large public companies have shown in surveys to have less confidence because of the trade war. There is a strong correlation between executive confidence and business spending. Tariffs are impacting earnings growth already. Earnings for the second quarter, which will be released soon, are projected to decline by 2.6%. Analysts are projecting that Q3 earnings will also be marginally lower by 0.3%. At the start of the year, Q3 earnings were expected to grow by 3.4%. A resolution to the trade war in the next few months would be a catalyst for stocks. If the trade war is prolonged, you’ll likely see it start to dampen our expectations for returns. Further trade issues with Europe and India could also impact growth expectations.
The market is expecting the economy to slow down in the near term but not experience a recession. A slowdown is when growth slows but does not actually go negative. A recession is when you typically see two quarters of negative economic growth. As long as we see growth only slow in the near term stocks should continue to perform.
Our stance has not changed since last quarter in terms of how we are positioning your portfolio. We are fully invested but as discussed early have added low volatility exposure to your portfolio. This seems like a prudent approach given a few of the headwinds we are facing.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.