Stocks delivered an 18.5% return in the first half of the year as optimism around potential Federal Reserve rate cuts countered moderating economic growth and rising trade and geopolitical tensions. We don’t believe similar gains will be replicated in the second half of 2019, but we think the fundamental backdrop remains favorable to support equities this year, though the path for stocks is likely to become bumpier.
Fed and trade expectations spur volatility –Markets are pricing in three rate cuts by year-end. While a rate cut is probable, we don’t expect economic data to be weak enough to trigger that many. Healthier-than-expected economic readings would be a positive outcome, but the thought of fewer Fed cuts could spur stock market volatility, given stocks rallied 7% in June in large part on the prospects of a looser policy. Similarly, we believe some form of a trade deal with China can be struck, but we doubt it will come swiftly or without further retaliatory rhetoric in the interim.
DNA of a Bull, Not a Bear – Historically, market expansions have ended when: 1) recessionary pressures take shape (unemployment rises by roughly 0.5%; business investment dries up); 2) corporate earnings decline; and 3) interest rates rise to restrictive levels (10-year rates average levels more than two times higher than they are today). We anticipate short-term pullbacks along the way, but the broader backdrop is far more consistent with an extended bull market than with one that’s nearing its expiration.
Late-cycle returns – The lack of overheating economic growth, average valuation levels and a proactive boost from the Fed could extend this phase. Historically, the final years of a bull market produced very strong gains (often a “blow-off” phase driven by over-optimism that brought about the ultimate peak). We expect positive but lower returns in the late stages of this cycle.
An equity weighting at your long-term target allocation remains appropriate, in our view. We recommend the largest exposure to U.S. large-cap equities, while international developed-market and emerging-market equities offer attractive opportunities for equity portfolio diversification.
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