May you live in interesting times… Forgive me if I have used this phrase in a previous article, but it is again on my mind. While the phrase is intended to sound like a blessing, it is always used ironically as a curse. Often attributed to the Chinese, though its origin is debated, it did come into prominence when used by Robert Kennedy in a 1966 speech.
These are indeed interesting times: the country has not been this divided since the civil war, Iran is again openly enriching uranium, North Korea is again testing missiles, trade tensions with China remain elevated, and the president today indicated that his next trade target may be India.
Global economic growth has been slowing but is showing signs of stabilizing. Economic growth in the United States too is slowing. GDP increased by 3.0% in 2018 and the conference board expects growth to slow to 2.5% this year and 2.0% next year.
With this backdrop, stock markets continue to climb the wall of worry and have performed very well during the first half of 2019. Through the first two quarters of this year the S&P 500 is up 18.5%, and the Dow is up 15.4%. International markets have also fared well with the MSCI Europe Index up 15.9%, the MSCI Japan up 8.5%, the MSCI China up 13.1%, and the MSCI Emerging Markets up 10.7%.
The United States has been experiencing what is now the longest economic expansion in its history at 121 months – just over 10 years. As pointed out earlier, growth is slowing to the point where the Federal Reserve is likely to act. It is now widely expected that the Fed will lower interest rates by .25% at their next meeting at the end of July. The market is expecting an additional .25% rate cut at the Fed’s September meeting.
Fed Rates cuts historically have been very good for stocks. Over the last 100 years there have been fifteen cases when the Fed has lowered rates in advance of recessions – in these situations stock markets have increased by an average of 11% over the next year (with most of the gains coming in months 9-12). In the eight instances when the Fed cut rates and the economy did not go into recession, markets gained by an average of 24% over the next year.
While the economy is slowing, it does not appear that we are heading into recession. Unemployment is at 50 year lows, inflation is low, energy prices are low, interest rates are low… Given that next year is an election year we can expect that leadership will do what it can to support the economy. It looks as if the Fed will be lowering rates with no recession – good for stocks.
Profits for the companies in the S&P 500 are expected to be $165 in 2019 and grow to $185 in 2020. The S&P 500 is currently trading at 2,980 or 16x earnings in 2020. Keep in mind that the S&P 500 has, on average, traded at 19X earnings when inflation is in the 1-3% range.
Stock valuations look reasonable and the Fed is cutting rates. If the U.S. can avoid recession and policy mistakes, stocks can do well in the months ahead.
Joseph H Ray