Plum Street Advisors
Q2 2019 Market Commentary – July 8, 2019
In the second quarter, the global stock and bond markets posted another positive result. All the broad asset classes had good returns – from US large stocks to emerging market bonds. Even gold, which can often be a counter-indicator, went up due to falling interest rates and rising geopolitical concerns.
The markets rose despite an abundance of broader concerns about the US economy. Significant risks include expected declines in year-over-year corporate earnings for the second and third quarters, falling corporate confidence data, expected slowing in GDP growth, and a continuing trade war with China.
For now, however, the expectation of a Federal Reserve rate cut (which could come as soon as the end of July) has buoyed the US stock and bond markets, and in turn global markets as well. Global markets might get another tailwind later this year if a hoped-for resolution to the US-China trade war is finally reached.
Despite the fact that all major asset classes went up, they are not equally expensive. US markets trade at a significantly higher multiple of earnings than European, Japanese, or emerging markets. Historically, these multiples have been more closely aligned. As always, we recommend a diversified portfolio across all of these markets, which will help to spread risk from the relatively highly-valued US market in this environment.
US stock markets rose across the board. Large stocks did better than small stocks in the second quarter. The total return of the Russell 1000 index of large US stocks was 4.25%, while the Russell 2000 index of small US stocks returned 2.10%. The tech sector has been leading the market higher over the past several years, and this year has seen a continuation of that trend. In the second quarter, growth stocks continued to do better than value stocks, as the Russell 1000 Growth index returned 4.64% for the quarter, compared to the Russell 1000 Value index total return of 3.84%.
Although both growth and value stocks have done well in the current economic recovery, value stocks have not risen as quickly, and this has resulted in a widening gap between the price of US growth stocks (as compared to their earnings) and the price of US value stocks measured the same way. By this measure, growth stocks are now more than 50% more expensive than value stocks – a gap we haven’t seen since 2002. In the long run, studies have shown that value stocks tend to outperform – particularly during market downturns – and we expect this historical trend will reassert itself in the coming years.
The MSCI EAFE index of developed market international stocks gained 3.68% (net, USD), while the MSCI Emerging Markets index of international developing countries edged up 0.61% (net, USD). Emerging markets have struggled recently, and this quarter the index was dragged down by a -4.02% return for Chinese stocks, which are by far the largest component of the emerging markets index.
Interest rates fell sharply in the second quarter, as the market started to anticipate that the next move by the Federal Reserve would be to lower rates. The benchmark 10-year US Treasury rate declined from 2.41% to 2.00%.
Bond prices move inversely to interest rates (because existing higher-rate bonds become worth more relative to the new lower-rate bonds being issued), and bond indexes across the board jumped as rates fell. The US Aggregate Bond index, which measures a very broad range of US bonds, rose 3.1% for the quarter. Treasury Inflation Protected Bonds as measured by the Bloomberg Barclays US TIPS index gained 2.9%, Short term bonds as measured by the Bloomberg Barclays US 1-5 Year index picked up 1.9%, and Global Bonds returned 1.5% (FTSE World Government Bond 1-5 Year index).
Commodities and Currencies
Oil prices swung sharply during the second quarter, as oil demand growth forecasts declined, US-China trade tensions continued, and several fuel tankers were attacked in the Gulf of Oman. Oil was down modestly for the quarter (-2.7% for Brent crude prices), but this masked significant intra-quarter volatility.
Gold jumped 8.8% (London spot prices), and is now up 10.2% for the year. Falling interest rates help the price of gold by making it relatively less expensive to hold.
Finally, the cryptocurrency Bitcoin rose dramatically in the quarter, rising 162%. More institutions are supporting the cryptocurrency, and Facebook’s introduction of its own cryptocurrency has revived interest in the space after a tough 2018, when Bitcoin fell approximately fourfold.
Although recent market returns have been very strong, it is not reasonable to expect this kind of performance into the future. The Russell 1000 index of large US stocks is up almost 19% in the first half of the year, and even the US Aggregate Bond index, a broad index of intermediate bonds, has returned over 6%. Unfortunately, bonds have posted that kind of return because rates have fallen so much, and yields for the US Aggregate bond index are now under 3%, which means lower interest rates for savers in the future. As for stocks, they have risen more quickly than earnings, which is not sustainable indefinitely either.
For the accounts we manage, we will rebalance them as markets move to ensure that you maintain your intended risk level. For those that we do not manage on your behalf, you may want to ensure that they have not become riskier than you intended. Over just the past three years, the US stock market has risen almost 50%, so you may be holding more stocks now than you realize. As always, rebalancing helps us maintain a consistent measure of risk in the portfolio and helps your portfolio earn a more efficient risk-adjusted return over the long run.
 S&P 500 Growth price per share divided by 12-month forecasted earnings per share compared to S&P 500 Value price per share divided by 12-month forecasted earnings per share as of 6/20/2019. Source: Yardeni Research.