The second quarter of 2019, as well as the first six months of the year, turned out to be unusually volatile and particularly profitable for those who were willing to tolerate the “noise” and stick with the plan. U.S. equities returned +4.20% for the quarter, with midcap stocks in the lead with a quarterly return of +4.35%.
The table below summarizes the performance of various domestic equity categories over the past 3- and 12-month periods.
Developed international equities were mostly “in-sync” with domestic equities and returned +3.75% for the quarter as measured by the MSCI EAFE index. Emerging markets were only slightly up in the same period, +0.95%, after a robust return of +11.35% in the first three months of the year (FTSE Emerging Index). We are finally seeing meaningful returns in the fixed income sector. Source: Morningstar
We consider allocations to bonds as a buffer in most of the portfolios we manage. This portion normally needs to be liquid and readily available for current or future cash distributions. We are pleased to see bond returns of +3.07% for the quarter (+6.10% year-to-date) as measured by the Barclays U.S. Aggregate Bond Index.
The potential effects of additional tariffs and continuations of the trade war with China have captured most of the investment news headlines. Much of the market volatility in the middle of the quarter can be attributed to the President’s comments on imposing tariffs on an additional $325 billion of Chinese goods. The U.S. has already imposed duties of up to 25% on close to $250 billion of products coming from China. Market participants were eagerly anticipating the discussions at the G-20 conference at the end of June which, thankfully, resulted in an agreement to resume trade talks. We note this truce had been heavily expected by the investors as the markets around the world kept going up in the week before the G-20 meeting. This reminds us about the efficiency and speed with which any relevant updates are absorbed by the markets. The chart below summarizes the status of the trade negotiations between the U.S. and China.
Source: U.S. Census Bureau, BBC Research
The Federal Reserve’s economic outlook and potential interest rate decisions are observed and analyzed by investors with the same intensity as any updates on the trade negotiations. Over the past six months, the expectations of potential rate hikes have been fully replaced by the expectations of rate cuts. The markets are anticipating two potential rate cuts this year: the first, with near certainty, in July or September and an additional rate decrease in the later months of the year. There is also a potential for a rate cut in the beginning of 2020 if the Fed perceives that the economy is slowing down. The current benchmark rate remains at 2.25% to 2.50%.
In line with the interest rate cut expectations, we have reduced or eliminated our allocations to short-term certificates of deposit (CDs) in many of our managed portfolios. These types of liquid investments were appealing in years 2017 and 2018 as interest rates rose and expectations of additional rate increases were in place. We will continue to use CDs in some client portfolios for liquidity purposes. Overall, we believe that short- and short-intermediate term corporate bonds are more attractive in this economic and interest rate environment.
We officially entered the 11th year of market expansion earlier this year, commonly referred to as the “bull” market. The bottom of the last “bear” market was reached on March 9th, 2009. Even though most of the economic indicators remain positive and, as the common adage states, “bull markets do not die of old age”, we continue to remind ourselves and our clients of the importance of a disciplined approach to asset allocation. As many of you already know, we believe a cash-flow based approach is the most objective way of defining each specific investment strategy. This may be a perfect opportunity to take some capital gains “off the table” and re-position our portfolios.
As you may already know, we fully re-balance most of the managed portfolios every January and July (in addition to any “tactic” and year-end adjustments such as tax loss harvesting). Given the market performance results, we expect to reduce allocation to equities in most of our managed portfolios in order to bring the overall allocation closer to the targets per each client’s investment policy. This gives us an opportunity to increase the allocation to fixed income investments that may be used for ongoing or future cash needs and potentially re-deployed back into equities when we experience another market correction.
As always, feel free to reach out to us and we will gladly assist you.