July 1st marked the point of the longest economic expansion in U.S. history which started on June 1, 2009. And this past week saw all three major equity indices reach all-time highs. In the first half of 2019, the S&P climbed 18.5%, having had its best first half since 1997. The unemployment rate of 3.7% sits near its lowest point since December 1969. Inflation continues at a relatively low and stable rate. And yet this bull market remains one of the most mistrusted and disliked ever. Why is that? And what should investors be doing with their portfolios?
At the same time that equity markets are reaching all-time highs, defensive indicators suggest that now is a time for caution. This includes gold’s price, which is close to a six-year high, the 10-year Treasury at 2.02%, which is near its lowest yield in nearly 2 ½ years, consumer staples and utilities indices, which are at or near all-time highs, and especially corporate bond prices, which have all rallied very hard in 2019.
Gold could be surging on fears of slowing global economic growth, global trade tensions, or concerns over new rounds of easing from the major global central banks. The same factors are likely driving the 10-year Treasury’s rally as well. The fact that consumer staples and utilities are at or near all-time highs is likely more indicative of investors that are still psychologically impacted by the most recent bear market of late 2007 to early 2009 – they want to be invested in equities but also want to be defensive by having “one foot out of the door” in case there’s a significant market decline. These sectors also tend to do well when rates fall given their larger dividends. Given the large move in the 10-year Treasury, it is not surprising that these sectors have rallied.
In Europe, a 10-year German Bund provides an unattractive negative yield of -0.40%. The 10-year Italian bond offers only 1.68% despite a still lackluster economy. Compare those two ugly yields to the relatively attractive U.S. rate of 1.95% and it’s not surprising that there is pressure on U.S. rates. European stocks have also done well with the Euro Stoxx 50 up 16.2% year-to-date on a currency adjusted basis. Stocks and bonds are being boosted by lower rates. On July 2nd the European Council recommended Christine Lagarde to succeed Mario Draghi as President of the ECB. She is a career politician who is not a trained economist and is widely expected to lean dovish in support of Draghi’s last round of easing likely in September. Continued monetary easing in Europe is likely to sustain downward pressure on U.S. interest rates.
And before we become too concerned about the first half’s 20.7% appreciation in the S&P 500, note that the market is “only” up 12.7% over the past twelve months due to the sharp down draft in the fourth quarter of last year. The decline in the 10-year Treasury from 2.69% at year-end 2018 to 2.02% today is likely due to the modestly lower economic growth outlook, rather than from a flight to safety. The Atlanta Fed’s GDPNow forecast for the second quarter is a mere 1.3% (first quarter GDP registered 3.1%). Recall that low interest rates mean less of a discount applied to future earnings—and that tends to increase stock valuations today.
The fact that we’re now into our 121st month of economic expansion and a bull market that’s in its 124th month has many on edge. The jobs report on Friday indicted the economy created over 200,000 net jobs in June. This is far more than the amount needed to absorb the 75,000 or so additional workers joining the labor force each month. This suggests that concerns that the recovery is sputtering out may be premature. But if it the economy does weaken materially, the Federal Reserve appears poised to cut interest rates possibly two times in the second half of 2019. We obviously can’t see around corners, but the setup at least is in place for stocks to move higher: full employment, low and stable inflation, a stock market that’s climbing the proverbial “wall of worry,” and low interest rates. Investors should work with their advisors in putting together a carefully constructed, diversified portfolio and keep in mind that patient long-term investing looks past the short-term noise.