At the beginning of the year we gave the following estimates as part of our forecast for the 2019 year:
U.S. GDP growth 2.8%
10 Year U.S. Treasury Yield of 3.35%
U.S. Stocks 15% plus
Here we are at the half-way point of the year and it is a good time to review and make any mid-course adjustments as warranted by the current situation.
Let’s start with our forecast for U.S. stock returns of 15% plus for the year. Through the first six months of the year U.S. stocks as measured by the S&P 500 on a total return basis have generated a greater than 15% return. We anticipated a rewarding environment for stocks this year, but; candidly we did not see the rise in stock prices happening as quickly as it did at this point of the year. Even so, we will take that strong move up by stocks with open arms.
With just under six months to go to complete the year, the elephant in the room question is “what happens from here?”. At this point the single biggest impediment to continued stock price increases lie with the direction of interest rates. There seems to be plenty of money in the system and with the significant decline in interest rates, not only in the United States; but throughout the world, a willingness to accept risk has increased and the beneficiary of that increase in risk appetite is the stock market.
For the time being we will continue to stay fully invested in our allocations to the stock market within our portfolios. However, at some point we believe we will transition from a stock market driven by liquidity and super low interest rates to a stock market that is driven by the earnings growth rates of companies. We keep flirting with the idea that stocks should move with earnings rather than liquidity and low interest rates only to have tariff wars, Brexit concerns and other issues gum up the works and we are back to easy money and low interest rates. The transition to an earnings driven stock market will most likely come with an uptick in rates and that combination will most likely lead to some disruption in the direction of the stock market. Until then we will stay the course; but, with a bit of an itch to lighten our exposure to stocks.
Relative to the national consensus of GDP growth for the 2019 year, our estimate was at the higher end of forecasts, estimating a 2.8% increase in growth. The first quarter of the year came in at a healthy 3.1% growth rate. The reality of tariff wars and the subsequent business disruption that causes is beginning to manifest itself in uncertainty and a corresponding caution by both consumers and businesses; not to mention to those involved in the tariff negotiations. Projected GDP growth for the second quarter just ended is for growth to slow to around 1.5%. The U.S. growth slowdown is reflective of a similar slowdown throughout the world. Political, be it tariffs, social strife or tensions between countries; i.e. the Iran nuclear treaty, events are eating at the heart of global growth and it will stay that way until some of those issues get resolved.
We continue to believe that from a tariff standpoint, all countries involved in discussions would like to see a resolution. At some point, a new normal will take root, whether that means there is no resolution to the tariff wars and we just adjust to the new levels or there is some meaningful resolution to issues that foster a continued inter-locking of individual countries to a global growth platform. While hope is not an investable commodity, we hope that egos can be restrained, and real progress can be made on the trade front. However, it is very difficult to navigate a course of progress and chart a timetable for such an end. With that said, we are lowering our anticipated GDP growth rate to a range of 2.2 – 2.5% for the year.
Our interest rate call at the beginning of the year for an ending year rate of 3.35% for the U.S. 10-year yield is beginning to look a bit ridiculous. The current yield is 2.05% and with our expectation that GDP will be lower and slower than our original estimate it would follow that interest rates do not move meaningfully up from here.
Yet, perhaps it is a streak of stubbornness, contrarian for contrarian’s sake or even an unwillingness to accept the lower rates forever mentality that seems so pervasive, we think interest rates will have a bit of an upward bias from here. Now, let us get the “speaking from both sides of the mouth” spectacle acknowledged with our next sentence. We do anticipate that the Federal Reserve will cut rates by a quarter of a percent this year. However, with wage gains over 3% and anticipated price increases for various products moving higher due to the tariff wars, we do think the yield on the 10- year U.S. Treasury will be in the 2.25 -2.50% region by year end. We continue to have very short maturities in our fixed income portfolios and we are exercising patience while we wait for an upturn in yields and lower prices before extending our investments to longer term maturities.
Thank you for the opportunity to work with each of you. May your summer be blessed with nominal sunburns and happy memories from adventurous vacations.