by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equities shed some of their recent gains last week as lukewarm economic and earnings data combined with increasing geopolitical tensions to put some pressure on stocks. Bonds generated positive returns following comments from multiple Federal Reserve policymakers which seemed to lend support for potentially larger rate cuts in the realm of 50 basis points.

There was little to report on from a conference call held last week between U.S. and Chinese trade representatives. The two sides continue to appear far apart on certain key issues. In comments made last week, President Trump stated that there is still a long way to go before a final deal can be reached and left the door open to the possibility of additional tariffs on $325 billion of Chinese exports.

Earnings Update
With 15% of S&P 500 companies having reported Q2 earnings, the blended earnings growth rate is -1.9% on a one-year basis. The relatively weak results so far were largely expected by the analyst community as the initial accounting boost from 2017’s tax reform begins to wane. The good news is that while corporate earnings have been somewhat disappointing on an absolute basis, they have actually largely exceeded consensus estimates. According to data from Factset, the percentage of companies reporting earnings above consensus estimates has been close to 80%; well above the historical average. Often times, market performance is driven by the difference between expectations and reality, and Q2 earnings season has thus far brought an above average level of positive surprises. Furthermore, the beginning of earnings season has seen a large number of companies from the financial services sector report, and many of these companies’ earnings have been hindered by the decline in interest rates that has played out over much of the first half of 2019. 

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Most major U.S. equity indices closed out last week at all-time highs, bolstered by seemingly solidified expectations that the Federal Reserve will opt to cut interest rates when it meets in just a couple short weeks. During his semi-annual testimony on Capitol Hill, Fed Chair Jerome Powell noted that uncertainties surrounding global growth and trade continue to cast a shadow over the economic outlook and that inflationary pressures may remain persistently weak. Despite these risks, the general tone of Powell’s comments was still relatively sanguine, supporting our own view that the economy remains relatively healthy, but that increasing weakness abroad could put a cap on the strength of future growth rates.

Setting Expectations
As long-term investors, one of the most important keys to success is discipline. However, maintaining that discipline over the course of a complete market cycle can be very challenging. Volatility can be difficult to bear, especially when the future seems uncertain and our financial well-beings are at stake. That is why we believe one of the best tools an investor can have is a realistic impression of what can be expected from their portfolio. That way, when that next “crisis” inevitably strikes, the element of surprise is diminished, and a decision based on emotion is less likely to be made.

The S&P 500 closed above 3,000 for the first time in history last week. A variety of factors have allowed stocks to climb to all-time highs this year, including expectations for easy monetary policy from the Fed, perceived progress with U.S.-China trade negotiations, and relatively healthy U.S. economic data. But with the U.S. stock market now up close to 20% over the past six months, it is important for investors to set expectations for the future of long-term returns.

For most of us, remaining disciplined requires an understanding of economic fundamentals and valuations, which are the two most important drivers of long-term returns (not Fed policy or trade relations). It is a core tenet of investing that valuations are an efficient predictor of future returns, and that buying stocks when they are cheap has historically been much more successful than buying stocks when they are expensive. Of course, after a strong 20% run over the course of just six months, stocks are more expensive than they were just a short time ago, but the good news for investors is that by most measures of valuation, stocks are still far from “bubble” territory. The current P/E ratio for the overall market stands at about 17x (meaning that investors are paying $17 today for every $1 of future profits), which is much lower than the 25x level that was seen during the tech bubble in the early 2000s. However, compared to the historical average of about 15x, stocks certainly are not cheap either.

As the current economic cycle continues to mature, it will be important for investors to recognize that from current levels, future returns are likely to be a bit lower than they were during the past several years. Luckily, even returns that are meaningfully lower than those achieved during the bulk of this bull market can still be robust enough in a world where inflationary pressures remain muted. With that in mind, if we are able to successfully reset our expectations, we are likely to put ourselves in a much better position to navigate future volatility with better grace and discipline. Often times, staying invested and avoiding the opportunity costs of missed profits can give us a head start on a prosperous retirement.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Equities continued to push higher during the holiday shortened week after the U.S. and China agreed to a temporary trading truce as the two nations continue to try and negotiate a long-term deal. On Friday, the U.S. Department of Labor reported stronger than expected job growth during the month of June, and that news caused stocks to pull back a bit from their highs as it was perceived that the news might decrease the probability of an interest rate cut during July. Bond investors are still pricing in a full quarter point cut at the July 31 Federal Reserve meeting. As we discussed in our quarterly commentary, equity and bond markets continue to project different levels of optimism about the global economy. Equity markets seem to anticipate that new economic stimulus will be enough to keep the economy firing on all cylinders over the next couple of years, while bond markets seem less enthusiastic.

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Equities:

Performance across individual companies and sectors was a bit choppy during the second quarter as investors wrestled with the shroud of uncertainty created by the tenuous trade relationship between the United States and China. Nevertheless, the U.S. equity market (as measured by the S&P 500) rode a strong June rally to new all-time highs, with optimism being fueled by rising confidence that central banks will provide the juice needed to stave off a global economic slowdown. That sentiment was felt worldwide, with international equities in both developed and emerging markets taking advantage of strong June rallies to end the quarter in positive territory.

At present, equity markets are painting a very positive picture of the future; one where central banks can continue to keep the current expansion on target even as it faces its stiffest competition yet in the form of slowing global trade, declining manufacturing activity, and rising geopolitical tensions. Whether that optimism will prove justified remains to be seen, but one only needs to go back to the 1990s to find an example where equity markets extended the rally for an additional five years after the final Fed rate hike.

Bonds:

With equity markets playing the role of Pollyanna, bonds are casting a far more pessimistic tone. Treasury rates continued their precipitous decline throughout the second quarter, with the yield on the 10-Year Note falling to its lowest level since 2017. The futures market is now pricing in more than 100 bps (1%) of rate cuts by the end of 2020. For reference, this would mean the complete reversal of four previous rate increases. Of course, when interest rates decline, bond prices rise, meaning that bonds joined equities in generating healthy returns for investors during the first half of the year.

Whether explicitly part of the policy agenda or not, the Federal Reserve has at the very least, shown that it is keenly aware of market expectations and sensitive to bouts of market volatility that may have been caused by its actions. There have been multiple examples over the past several months of Fed representatives providing what might be construed as strategically timed comments that seemed to help sooth markets during bouts of volatility. Thus, current market expectations may have wedged the Fed between a rock and a hard place, where it risks disappointing markets and tightening lending conditions if it keeps interest rates above what the market is calling for. While we continue to believe that the fundamentals of the economy remain strong enough that a recession is not on the near-term horizon, the Fed may ultimately conclude that with inflation still in check, a preventative “insurance cut” (as it has come to be referred to in financial circles) may be its best course of action for keeping the economic expansion on the path of least resistance.

Outlook:

With equities and bonds seemingly at odds with one another, there are some interesting and challenging implications for portfolio construction. In the current backdrop, the only way that both the stock and bond markets can be proven right is if the bond market has correctly predicted that the Fed’s concern over economic growth will push it into an aggressive mode of monetary easing (i.e. significant rate cuts), and that this monetary easing will be impactful enough to enable equities to charge onward. There is little in the last 10 years of economic history to suggest that this isn’t a plausible scenario (central bank intervention in the United States has been quite effective since the financial crisis), but the next several months will go a long way in helping us learn whether the bull can be tamed. At this point in time, we remain cautiously optimistic and continue to recommend a balanced, neutral approach to portfolio positioning.

VIDEO: Q2 2019 Market Commentary – Connor Darrell CFA, Head of Investments, shares Valley National Financial Advisors’ review of the second quarter, and an outlook into the second half of 2019. WATCH NOW

by Connor Darrell CFA, Assistant Vice President – Head of Investments
A quarter where trade tensions and geopolitics led to choppy returns ended on an optimistic note as the U.S. and China agreed (once again) to hold off on implementing additional tariffs in an effort to resurrect the ongoing trade negotiations. U.S. equities finished the week largely unchanged, but capped off a strong month of June which saw stock prices rise by over 7%. 

As the second half of the year kicks off, investors will begin turning their attention toward Q2 earnings. Analysts are forecasting a second straight quarter of declining S&P 500 earnings, with the weakest growth expected among companies with large, complex global supply chains; another by-product of the ongoing uncertainty surrounding the future of global trade.

Q2 Commentary Now Available – valleynationalgroup.com/Q22019
Equities and bonds have both started the year at a torrid pace, but returns have been driven by very different underlying tones. We explore the conflicting signals that returns in the stock and bond markets are sending in our latest quarterly commentary.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
The equity and bond markets continued to send different signals last week after comments from Federal Reserve Chairman Jerome Powell helped propel the S&P 500 to new all-time highs but put further downward pressure on bond yields. The equity market also benefitted from an announcement by President Trump that he will hold an “extended meeting” with Chinese President Xi Jinping during the G20 Summit in Japan this week. The ongoing trade dispute between the United States and China continues to be a major factor for both equity markets and the Federal Reserve, as the slowdown in trade activity is likely to be a hindrance to economic growth.  The total impact of trade policy on economic activity over the long-term is not easily quantified, making the Federal Reserve’s job even more difficult.

The rally in equities this month has come despite signals from global bond markets that global growth is slowing and that inflation is nowhere to be found. Equity markets are betting that central banks will have enough ammunition to stave off a meaningful decline in economic activity. Elsewhere, tensions in the Middle East have continued to push oil prices higher. On Thursday, President Trump authorized and then cancelled airstrikes against Iranian assets in response to the series of attacks that left several oil assets damaged in and around the Strait of Hormuz. 

Geopolitics Not A Major Factor for Investors
In response to crippling economic sanctions that have led to a 90% reduction in the nation’s oil exports, Iranian-backed forces have begun lashing out at U.S.-allied interests in the region. The American response has been firm, leading many to speculate that the potential for a military conflict has increased. While the recent developments are concerning for a global economy that is struggling to maintain momentum (and of course even more so for the human lives that may be put in danger should tensions continue to intensify), history tells us that these types of events tend to only impact markets for a short period of time. Given the location of the risk (along a major oil trade route), we could continue to see volatility in the price of crude, but investors should avoid overreacting to geopolitical developments and maintain a disciplined, balanced allocation within their portfolios.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Markets were largely unchanged last week as investors weighed mounting geopolitical concerns against the potential for an easing of monetary policy. Technology stocks were under pressure for a majority of the week as the ongoing trade dispute between the U.S. and China has hurt global microchip sales. 

Economic data released throughout the week did little to increase optimism that the global economy can stave off a slowdown in economic growth rates. Retail sales grew 0.5% month-over-month, slightly below the consensus forecast of 0.6%, and the University of Michigan Consumer Sentiment Index ticked down to 97.9 from May’s reading of 100. Elsewhere, a survey of businesses revealed a decrease in confidence among large multinational corporations; the fifth such decline in as many quarters. Most key metrics remain healthy in absolute terms, but the rate of change has certainly tilted lower in recent months.

Watching the Federal Reserve (Again)
Last week’s inflation data revealed a month-over-month increase in consumer prices of just 0.1%, a far cry from the Federal Reserve’s annual target. The Federal Reserve will meet this week to discuss monetary policy and markets will be paying close attention to the committee’s decision on interest rates, as well as its commentary on the economy. The bond market is continuing to price in expectations of forthcoming rate cuts, and the weakening in inflation expectations has only bolstered those expectations. The Federal Reserve has consistently communicated that its decisions are “data-dependent”, and the data has become increasingly difficult to interpret as a result of last year’s tax cuts and this year’s escalation in trade tensions. Ultimately however, investors should not concern themselves too much with the level of interest rates or the Fed’s next policy move. The fact that inflation remains so low is actually a positive sign that the economy has more room to expand, since inflation is often a key sign of tightening in the economy that precedes key inflection points in the economic cycle.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
A weaker than expected jobs report fed rising speculation that the Federal Reserve will opt to lower interest rates in the coming months, leading to a rally in equities that saw the S&P 500 rise by more than 4% last week. Global manufacturing data also released during the week seemed to lend further credence to this sentiment as trade tensions pushed global manufacturing activity into contraction and down to its lowest reading since October of 2012. It is becoming increasingly clear that the uncertainty related to global trade is having an impact on business investment, and with the tensions likely to persist in the near-term, investors should be prepared for additional volatility in markets. 

Don’t Rely on the “Powell Put”
With the sudden escalation of global geopolitical uncertainty threatening to slow business investment and reduce economic growth, Federal Reserve policymakers have found themselves in a very difficult (und unique) environment in which to operate. Perhaps in response to the very high levels of uncertainty coming from other areas of the financial world, it seems that Fed officials have made a concerted effort to be extra communicative in recent months. For example, during the last week of May (which included a market holiday), there were 13 separate speeches given by Fed officials; a staggering number when you consider that the Federal reserve already meets two times per quarter and releases detailed notes for public consumption after each meeting. It seems that the Federal Reserve has felt the need to address the shorter-term shocks to markets that have resulted from setbacks in trade negotiations and other geopolitical concerns by constantly reminding investors that it is watching things very closely. 

The timing of many of these statements has coincided with rising levels of volatility in markets, leading some to refer to current Fed policy as the “Powell Put.” With the Fed under the microscope, it is easy overestimate its power and lose focus on all of the other factors that drive markets over the long-term.  In the context of a $20 trillion economy, one or two 25-basis-point adjustments to short-term interest rates are unlikely to have a profound impact on the trajectory of economic growth, and investors would be well-served by broadening their focus. In fact, we would argue that the most important thing for investors to focus on is portfolio construction, and that this is the case no matter what stage of the economic cycle we find ourselves in. The interaction of monetary policy, the economy, and the stock market has become a defining characteristic of the current economic cycle, but it shouldn’t be the key input to determining the composition of one’s portfolio.

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Markets slid lower last week as concerns over trade policy remained top of mind for investors. On Thursday, President Trump announced that the United States would begin assessing a 5% tariff on all U.S. imports from Mexico unless the Mexican government began taking a more active role in reducing the flow of Central American migrants seeking asylum in the United States. The news pushed markets into “risk-off” mode and stoked concerns that major North American supply chains could be materially disrupted. The U.S. 10-year treasury reached its lowest level since September of 2017, which resulted in a deeper inversion of the yield curve and a strong week for bonds. 

Watching the Economic Data
Amid all of the uncertainty permeating through markets regarding trade policy and its eventual impact on global economic growth, the Fed has continued to express its intention to remain “data dependent.” This week, markets and policymakers will have access to updated PMI manufacturing data, which has been trending lower for several months. Friday will also bring the monthly jobs report, which has been consistently strong. Overall, while economic data releases have been overshadowed by trade negotiations in terms of news coverage, they are arguably just as (if not, more) important because they provide us with tangible evidence of how the economy might be weathering the geopolitical uncertainty. And as we continue to march along toward the 11^th year of the current cycle, it will be increasingly important to watch the economic data for signs of an inflection point.

by Connor Darrell CFA, Assistant Vice President – Head of Investments

Geopolitical Update: China & Iran Represent Risks
We have raised our “International Risks” rating to a 7 from a 5 following recent developments in the Middle East and escalating tensions between the United States and China. We continue to stress that geopolitical events tend to have a smaller impact on markets than fundamental economic factors such as GDP, corporate earnings, and consumer confidence, but believe that recent news flow warrants investors’ close attention.

Earlier this month, the Trump administration ordered the deployment of significant military assets to the Persian Gulf, citing intelligence that suggested a rising probability of Iranian attacks on U.S. interests in the region. The Iranian economy is under significant pressure as a result of U.S. sanctions, and there appears to be growing concern within the Iranian government that Donald Trump will be re-elected in 2020. We have already seen multiple instances over the past few weeks where Saudi oil assets were sabotaged, and the general consensus in the intelligence community is that these attacks were carried out by Yemeni rebels on behalf of Iran. U.S.-Iranian relations are at their weakest level in years, with Secretary of State Mike Pompeo and Iranian Foreign Minister Mohammad Javad Zarif never having directly spoken to one another. The lack of a direct channel of communications between the two chief diplomats underscores a growing concern that any potential confrontation may be blown out of proportion and escalate quickly. Any meaningful escalation of tensions in the region would have the potential to de-stabilize oil prices (20% of the world’s oil travels through the Strait of Hormuz on its way to end markets) and further strain the United States’ relationship with China.

The trade negotiations between the U.S. and China have been thoroughly explored in virtually all media outlets, as well as in previous iterations of The Weekly Commentary, but there is another dimension to the discussions which extends beyond trade deficits and trade surpluses; the race to 5G. It has become increasingly apparent that the United States government views the race to establishing and dominating the world’s first 5G (fifth generation) cellular network technology grid as a matter of national security. First adopters of 5G technology are expected to sustain a meaningful long-term competitive advantage, and China is heavily focused on pushing to challenge the United States as the dominant force in the evolution of the world wide web. China’s approach to controlling information on the internet is vastly different from the openness championed by traditional American values, and in many ways, the race to 5G represents a philosophical battleground over the flow of information; one that has continued to escalate in recent weeks.

Shortly after the most recent round of trade discussions fell through, President Trump announced a ban on Chinese smartphone manufacturer Huawei. The ban blocks U.S. companies from doing business with Huawei, and essentially prevents it from accessing key inputs to its manufacturing process (which are produced by American companies). We see this decision as a clear and meaningful step to explicitly hamper China’s advancement in 5G technology and keep U.S. companies on a level playing field (Chinese companies receive direct support from the Communist-led government).  From an investor perspective, a meaningful disruption to the supply chain of technology equipment or additional bans would have the potential to cause volatility in equity markets as companies’ revenue streams are impacted. Even if a trade deal is reached within the next several months, the complexities of the technological rivalry between the two countries is likely to persist and will represent potential challenges for global companies which may be caught in the crosshairs of further policy action. Furthermore, a prolonged period where tariffs are imposed on Chinese goods would likely have a negative impact on economic growth. Recent research published by the New York Fed estimated that the newest round of tariffs could cost the average American household $831 per year. The focus on China and trade has the potential to draw the market’s focus further away from fundamentals and toward the unpredictability of the president’s Twitter feed. Such an environment will be very difficult to navigate for market timers and short-term traders.  In our view, the best defense for this type of uncertainty is broad diversification and discipline. We will continue to utilize The Weekly Commentary to share our thoughts on new developments as they unfold.