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Market Outlook: 3rd Quarter

By Kate Warne July 17, 2019

It’s been more than 10 years since we experienced a stock market drop greater than 20%, which would bring the current bull market to an end. What’s the latest on this long-running bull market?

A look at the first half of 2019

Despite many challenges, most asset classes had returns that were well above average in the first half of 2019:

  • The S&P 500’s 18.5% return was its best first half since 1997.
  • Global equities increased by double digits.
  • A shift toward easier monetary policy by the Federal Reserve and other central banks was a key driver of equity market performance.
  • As interest rates fell, bond returns were also strong.

We don’t expect double-digit equity market returns to continue, but a strong first half has been good news in the past – stock market returns for the entire year have been above-average after the S&P 500’s return exceeded 15% in the first half.

In addition to support from the Fed, we think the fundamentals of slower but positive economic and earnings growth will continue to fuel the bull market. The pace of economic growth is likely to slow modestly, back to around its 2.3% average rate during this long-running expansion. While earnings growth is also slowing, companies have been skillfully navigating rising costs due to higher wages, higher tariffs and supply chain disruptions, and in many cases, they have continued to eke out higher profits. That’s why we recommend you stay invested in a variety of equities including small- and mid-cap stocks as well as large-cap companies.

Current headwinds

We don’t think either a bear market or a recession is likely in the near term, but we do expect more signs of slowdown as the economy and earnings return to more modest growth. Investors also need to prepare for more volatility as markets may be buffeted by many ongoing issues, including the negative impacts of higher tariffs and the ups and downs related to the U.S.- China trade negotiations. We think the trade negotiations with China are likely to be lengthy and complex, but we expect an agreement will be reached eventually. In addition, political uncertainties in Europe and other parts of the world, tensions with Iran and slower growth in China are headwinds.

But don’t forget that many of these current headwinds could be calmed quickly, and policymakers are taking actions to stabilize and improve the prospects for global growth. In addition to the shift in Fed policy toward rate cuts, central banks in the rest of the world are also evaluating rate cuts and more stimulus policies. And China is addressing its economic challenges with another round of pro-growth policies.

Fed in the spotlight

The Federal Reserve is in the spotlight, partly because of the shift in Fed policy toward stimulus that’s helping support equities and keeping interest rates low. The Fed intends to help extend the life of the expansion by cutting short-term interest rates as needed later this year.

That’s one reason long-term rates like mortgages have already declined, and we expect interest rates to continue at low levels. But investors aren’t sure how many times the Fed will cut rates. That depends on future data including how fast the economy grows and whether global concerns begin to fade.

The Fed can cut rates partly because inflation remains less than its 2% long-term target. Despite rising wages and higher tariffs, the effects of globalization, the strong U.S. dollar, demographics and productivity improvements have kept inflation low, which seems likely to continue short-term but probably won’t last forever. That’s why we recommend a laddered bond portfolio with enough cash and short-term bonds to fund short-term needs as well as an appropriate allocation to high-yield bonds.

Investing internationally is important

We think an appropriate allocation to international equities is important, especially after times when U.S. equities have outperformed. We’ve seen in the past that performance rotates, and over time, owning a combination of U.S. and international stocks can reduce the swings in the value of your portfolio.

In addition, we think international stocks are attractive because developed-market equities and emerging market stocks both have better valuations than U.S. stocks as well as higher dividend yields. An improvement in growth prospects in the rest of the world should help boost the outlook for international stocks in our view, which would be good news for investors who keep an appropriate international allocation in their portfolio.

Advice for investors

As this market cycle ages, remember that bull markets and expansions don’t die of old age, and they both seem well-positioned to last longer. As they age, though, we can expect more volatility, not less, combined with lower returns.

Market swings can be nail biters, but long-term investors realize that staying invested over time, even during painful pullbacks, is likely to be a better approach than trying to time the market. You can’t control market volatility, but you can be make regular adjustments and rebalance the mix of stocks and bonds to keep your portfolio prepared and your expectations realistic. In investing, it’s how well you stick to your investment strategy that matters most in the long run.

Important Information:

This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation.

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