Thursday, 18 July 2019 20:38

Market outlook Third Quarter 2019 Featured

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Lakeland Wealth Management

It is already the second half of the year; markets rebounded nicely from the last year-end correction. When markets bounce, they do quickly, patience, and long-term view on the investments are essential when we invest in the stock market. The latest bull market is the longest in history started in March 2009 and completed a decade and moving forward, while unemployment is historically low; inflation is still below the Fed’s target 2 percent rate. Market critics were skeptical about the resilience of the markets since the beginning of the turnaround; still many could not digest the continued economic expansion. Once the legendary investor John Templeton said: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

The market is now at the matured stage and clearly showing the aging factor. The second quarter of 2019 is the peak earning quarter, and we should start seeing a decline in the earnings in the coming months. That is the nature of the economy, economic slowdown already started partly because of the global trade and supply chain issues, but the growth is still positive. That does not mean the market expansion is going to end abruptly. As with changes in the economy, our asset allocation has been drifting from equities to fixed income assets. However, we are still overweight in stocks to take advantage of continued economic expansion.

Historical Interest ratesp1

Since Federal Reserve raising interest rates since the beginning of 2016, the bond returns were abysmal, but that trend might change going forward. Federal Reserve indicated more accommodative policy in the June meeting, and willing to cut the interest rates in the coming months due to uncertainty around the trade war with China and the slowing global economic trends. Interest rates in most parts of Europe and Japan are in negative territory. Major economies like China, Japan, Australia, European Union, Brazil, and Argentina already in the path of easing their monetary policies, which some many economists in the US see as a competitive disadvantage.

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In general, higher interest rates keep the currency valuations higher; thereby, US exports can be expensive to our trading partners or lower foreign currencies keep import costs more economical, thus higher trade deficits. Skirmish trade issues and along with tepid inflation are the primary concerns to the FED which we see another reason to cut its interest rates anywhere from 25 basis points to 50 in the upcoming July meeting. Alternatively, they may spread the 50 basis points rate cuts from July to September meetings. Expect lower bank interest rates as much as 50 basis points (0.5%) and a further drop in both 15 year and 30-year mortgage rates.

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Yield-Curve: In the late first quarter, inversion of the US yield curve spooked many and got a lot of media attention. When long-term interest rates fall below short-term rates (3 months), it is known as yield inversion. Financial institutions borrow at the short end of the yield curve and lend based on 10-year bond yield. During the inverted yield curve times, financial institutions have less incentive to lend funds. However, the recent Fed announcement of the easy monetary policy shifted lower end of the interest rates below the 10-year rate. With both expansionary Monetary policy (lower rates) and expansionary Fiscal policies (Budget deficits), the future state of the yield curve would be upward sloping, and we believe the economy will keep humming for the next year.

Lower rates mean lower cost of capital (corporations pay less on the debt), prolonged lower rates are good for the stock prices. For the past decade, the nominal GDP grown more 50%, personal consumption makes up three-fourths of the GDP contributor. So far, the household balance sheet is in great shape; consumer confidence is all-time high; unemployment is the lowest point; household savings rate is in the upward trend at six percent, and the wage growth trend is positive. Relative earnings yield from the stocks is a lot higher compared to bond yields. All the signs are pointing to further market expansion for the year 2019.

Sreeni Meka

July 18, 2019

 

 

 

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