Markets are off to a strong start in 2019. The S&P 500 Index was up 18.3% for the first six months—and bonds, as measured by the Bloomberg Barclays Aggregate Bond Index, were up 6.1%. Many investors have been caught off-guard by the surprisingly strong performance, especially following last year’s tumultuous fourth quarter, which now seems like a distant memory.
The three keys to understanding the first half are:
- Federal Reserve policy
- Interest rates
- Ongoing trade negotiations
Shifting Federal Reserve Policy
First, the U.S. Federal Reserve Bank abruptly changed policy in early January. Last fall, the Fed raised rates, indicated future hikes were in store, and signaled that the shrinking of its balance sheet was on “auto-pilot.” The Fed was clearly tightening monetary policy at the end of last year, and markets did not respond well as the S&P 500 Index was down 13.5% in the fourth quarter.
In early January, however, the Federal Reserve Chairman, Jerome Powell, walked back many of his comments, essentially stopped hiking rates abruptly at the beginning of the year, and the Fed is now expected to start cutting rates in July. The change from tightening to easing is a big contributor to the stock market’s rise so far this year.
Declining Interest Rates
Second, interest rates significantly declined, with the 10-year U.S. Treasury yield going from its recent high of 3.2% in November to a low of 2.0% on June 28th. The large decline in rates drove bond prices higher, as bond prices go up when bond yields go down.
While the Federal Reserve’s change in policy direction contributed to lower rates, the main driver has been declining growth expectations, which is why the Fed is no longer hiking rates. Economic growth is showing signs of slowing.
While it’s difficult to point to a single cause, ongoing uncertainty surrounding trade and tariffs is certainly one factor weighing on growth.
Volatility Due to Ongoing Trade Negotiations
Third, the ongoing trade war introduced volatility into the market as investors attempted to price in the latest developments that came via Presidential tweets. For example, the stock market sell-off in May was precipitated by a new round of unexpected tariffs against China.
Unfortunately for investors, the possibility of an unexpected, market-moving tweet will continue to be a real possibility.
While understanding what brought us to the present moment is a worthwhile exercise, investors need to consider what will happen from this point forward. We believe:
Market conditions remain balanced, interest rates should trend higher over time, and trade will continue to cause volatility.
Market Conditions Remain Balanced
While we are now 10 years on from the Great Financial Crisis (GFC) lows set in March 2009 and the market is up nearly 20% in the first half of this year, there are no definitive signs that the bull market is near its end. Valuations are rich but not extremely so, the Federal Reserve is easing not tightening, inflation is below long-term averages, and the economy is clearly not overheating.
In addition, sentiment is not overly bullish. Bond ETFs have seen significantly more inflows this year than stock ETFs indicating investors are not wildly optimistic. At the same time, the market is overbought in the short-term, and it’s normal for the market to have 10% or greater intra-year declines even in up years. This is not the time for excessive risk-taking.
Interest Rates Should Trend Higher
We do believe interest rates will trend higher over time. While central banks around the world have recently taken steps to ease monetary policy, the drastic steps these entities implemented following the GFC are coming to an end. Interest rates should head higher as monetary policy normalizes.
Trade Wars Continue to Cause Volatility
While predictions are always fraught with uncertainty, we are confident that trade headlines will continue to cause market volatility. Trade negotiations between the U.S. and the rest of the world, especially China, are not yet resolved. We expect some future headlines will indicate trade deals are closer while others will identify setbacks in trade negotiations.
Investors should expect trade-induced volatility but can take comfort knowing markets are sitting at or near all-time highs despite a trade war that has been going on for more than a year.
What Does This Mean for Your Portfolio?
In summary, given the dynamics of this environment, we believe clients should consider the following actions:
- Take a look at mortgage rates
- Favor short-term bonds, especially stable value
- Take a long-term investment approach
First, current and prospective homeowners should take a look at their mortgage rates. Thirty-year mortgage rates have declined by more than 1% since last fall. If you have a mortgage rate that is significantly higher than current rates, if you are considering purchasing a home, if you are considering switching from a thirty-year to fifteen-year mortgage, or if you are considering switching from an adjustable rate to a fixed-rate mortgage, now may be the time to do so.
Second, investors should favor short-term bonds as interest rates have declined significantly. When interest rates go back up, longer-term bonds will see larger prices declines. Stable Value funds in 401(k) plans are particularly attractive as they yield nearly as much as long-term bonds with much less sensitivity to changes in interest rates.
Finally, we are not market timers here at Curi Wealth. We are long-term investors and take this approach on behalf of our clients. Now is the time to make sure you have a well-diversified portfolio—designed to meet your specific financial objectives and constructed to weather both good markets and bad markets. We never know with certainty when the market will sell off, but we do know the market will decline from time to time.
If you have questions about recent market performance or would like to review your current portfolio, please reach out to our Curi Wealth team.
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