Second Quarter Market Review
The second quarter of the year continued the first quarter’s impressive run, with the S&P 500, Dow Jones, and Nasdaq reaching all-time highs. Despite growth-oriented names like Apple, Amazon, Google, and Netflix receiving most of the headlines, the story this quarter was the continued market-leading performance of international markets, where both developed and emerging markets posted solid quarter and year-to-date returns. Foreign markets outperformed their domestic peers largely due to a rebound in economic activity and a general weakening of the US dollar contributed to solid corporate earnings. These returns are all the more impressive considering markets brushed off several terrorist attacks and the threat of populist elections that had the potential to change the course of the European Union.
Stock leadership was relatively unchanged, with a handful of growth oriented firms–mainly technology firms–continuing to perform well and lead markets higher, while value and small cap names trailed. It’s easy to forget that this time last year markets were in an earnings recession with many wondering if the environment was deflationary. A year later, asset classes have twelve month returns in the double digits. Moreover, second quarter earnings are shaping up to be the best since 2011, as companies justify their higher valuations. Major markets in the US, Europe, and Asia have yet to experience more than a 5% decline this year. The last time markets went this far into a year without all three suffering a 5% pullback was in 1993.
Fixed income returns trended higher this quarter as interest rates and bond yields declined while the yield curve flattened due to lower inflation expectations. This flattening of the yield curve would be concerning if it was related to a slowdown in growth. However, in June the Fed raised rates for the second time this year and cited relatively positive economic data (job growth and manufacturing data) as rationale for the move, a sign the economy is on solid ground. We remind investors that just a year ago the 10-year US Treasury was yielding 1.5% before climbing to 2.6% in late March. We believe interest rates will continue to grind higher amid fits and starts.
We believe we are in the midst of a global reflation of assets from unprecedentedly low levels of interest rates and growth. Although we are later in the economic cycle, 9 years post recession, interest rates and inflation remain low, liquidity is prevalent, and growth remains lackluster but positive. In our mind, these factors present a still-decent scenario of economic growth in the short-term, absent unforeseen geopolitical risks. This being said, the Fed is in uncharted waters as it looks to gently raise interest rates while shrinking their massive $4.5 trillion balance sheet, which could lead to bouts of volatility, both to the upside and downside.