Q2 2019 Will the FED be Our Friend
Commentary from the Investment Committee of Coral Gables Trust Company
Q2 2019 – Will the FED be Our Friend?
The second quarter had its fair share of volatility due to news events on tariffs and intensifying trade disputes, but thanks to a strong showing in June, the market continues to shrug off these concerns and post record highs. The S&P 500 returned +4.30% for the quarter and is higher by +18.54% YTD, making it the best first half return in twenty-two years. The technology heavy NASDAQ enjoyed a quarterly gain of +3.87% and is higher by +21.64% YTD. On the economic front, employment data released for June surprised to the upside with a robust jobs headline number, while the unemployment rate remained below 4.0% and wage growth held steady. Even with the unemployment rate hovering at a fifty-year low and real wages increasing in line with productivity, the economy continues to display muted inflationary pressures. Despite the global growth concerns, the U.S. economy remains healthy with the first quarter GDP reading at 3.1%. As we write, second quarter earnings season begins as investors anxiously wait to see if earnings growth is slowing as much as analysts have forecasted at a decline of -2.6% for the quarter. Guidance will be important which will shed light on the state of corporate America in the face of all the tariff uncertainty.
President Donald Trump and China’s President Xi Jinping reached a trade truce at the G20 summit in Japan, agreeing to re-start trade talks and suspend new tariffs. President Trump confirmed that the U.S. would not be adding tariffs on $300 billion worth of Chinese imports, but the current 25% tariffs on $250 billion worth of Chinese exports would remain in effect. In May, China retaliated by imposing duties on $60 billion worth of American products. China wants the U.S. to remove all existing tariffs once a deal is reached, but the U.S. would like to have an enforcement mechanism in place to make sure the terms of the agreement will be honored. We continue to believe that a deal will be reached eventually, but the market has come to terms that this could drag on for months.
At the June Federal Open Market Committee meeting, Chairman Powell continued to express patience and accommodation in the Federal Reserve’s policy. Chairman Powell reinforced this stance by stating that the Federal Reserve is willing to ease if conditions deteriorate. The market is expecting a rate cut of at least 25 bps (basis points) and equities have responded positively. In addition to rate cuts, the reduction of the Federal Reserve balance sheet may also come to a stop adding another element of monetary accommodation.
With the markets at record highs and the U.S economy continuing to display strength, the bond market is telling a much different story. After easily breaking through the 2.00% level this quarter, the 10-year treasury remains stubbornly low which does not coincide with the sturdy economic back-drop. The 10-year treasury now yields less than the 3-month treasury bill. Global uncertainty and anticipation of lower rates courtesy of the Fed are the main reasons for the bond market strength. Foreign bonds are up YTD while the Barclays Aggregate Bond Index is higher by +6.11% YTD.
International markets are participating in the rally with the MSCI EAFE Index closing the quarter up +3.97% and higher by +14.49% YTD. Emerging Markets ended the quarter +0.74% and are up +10.76% YTD. With the continued economic weakness in Europe, ECB President Mario Draghi is expected to cut interest rates which are already negative, as well as, relaunch the bank’s quantitative easing to help reignite growth within the region. Mr. Draghi’s term is up in October and IMF chief Christine Lagarde is being considered as his successor. With most major geographies looking to implement more accommodative monetary policy, we believe this will continue to support equities in the medium-term.
Thoughts on Asset allocation
During our most recent Investment Committee meeting, we decided to adjust one of our managers in the International equity arena. The Cambiar International Equity strategy has been replaced with the Pear Tree Polaris Foreign Value strategy. Extensive due diligence was performed on the Pear Tree Foreign Value and they possess the characteristics we look for like downside protection, conviction and stable investment process. Overall our investment managers are performing as expected both within equity and fixed income and we have elected to keep our asset allocation the same for now. The first half rally has led to richer market valuations at a time when corporate earnings are losing momentum and struggling to post year over year gains. To counter this concern, we continue to have a slight tilt to “value” within our asset allocation.
As active managers, we look for investment talent that can weather tough market environments and protect capital in times of turbulence and geopolitical distress. We remain confident that we have selected superior managers in our equity and fixed income portfolios. Listed below is a subset of our equity and fixed income managers that performed exceptionally well in the quarter.
Investment Manager * Q2 2019 Return Manager Benchmark______
Confluence International +7.28% +2.81% MSCI EAFE TR
T. Rowe Price Mid-Cap Growth +5.70% +4.40% Russell Midcap Growth
AMI Asset Management +5.31% +4.64% Russell 1000 Growth
PIMCO Investment Grade Bond +4.55% +2.85% Barclays Intm Gov/Cred
Polen Capital Large Cap Growth +6.18% +4.64% Russell 1000 Growth
T. Rowe Price Emerging Markets +1.76% +0.61% MSCI Emerging Mkts
*Returns are expressed as composite returns. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214