Second Quarter Commentary

Stocks finished the quarter near record highs despite a slowing global economy. There was little change in the economic data or the outlook from the prior quarter. The on again, off again Chinese – American trade negotiations achieved little progress. Interest rates extended their decline, as central banks became increasingly accommodative. US treasury prices increased as investors anticipate multiple rate cuts through year end.

As the quarter progressed, volatility in equities increased. Stocks initially rallied on an accommodative fed, upbeat growth prospects and decent earnings reports. As global economic forecasts moderated in May, stocks declined. Stocks rallied into the end of the quarter once equity investors realized that the probability of a Fed rate cut was increasing.

Escalating global trade tensions is the primary explanation for the global slowdown. The US threatened to impose punitive tariffs on Mexico unless it was more serious about stemming the flow of illegal immigration. While this spat was eventually settled, the trade dispute with China has endured. This trade conflict could become problematic as it involves the two largest economies in the world. The US also threatened to impose tariffs on European manufacturers. Trade uncertainty led to diminished business investments and curtailed consumer consumption.

Central banks have been quick to react to the economic slowdown by tilting towards a more accommodative stance. There were strong hints at the last Fed meeting that a rate cut was likely at their next meeting (late July) if there is no acceleration in GDP growth. Slow downs are not atypical during expansions, especially at this late stage of the business cycle. With the Fed willing to cut rates, it is likely that growth will re-accelerate in the second half of the year.

With lower interest rates, Canadian bond prices rose and provided a robust 2.5% return during the quarter. As we currently do not anticipate a recession, interest rates have probably bottomed. Future bond returns should reflect the prevailing bond yield, which is in the low single digits.

The stock market remains near record levels which is partly related to historically low interest rates. Valuations can best be described as full, being neither cheap nor hideously expensive and modestly above their long-term average. We are still positive on the outlook for stocks, but have difficulty making a case for significant upside. Although we still believe that stocks are more attractive than bonds, we are beginning to temper our bullishness. Stocks are vulnerable to a correction due to slowing earnings growth and their run since the beginning of the year. We are getting increasingly conservative with respect to the stocks we hold for clients and are gravitating to companies that are not particularly economically sensitive. If anything, we prefer stocks where performance will be a function of something other than the economy. We prefer catalysts that involve a turnaround, a restructuring or being dependent on a cycle that is independent from the economy. We have also trimmed positions that have performed particularly well leading to cash being at more elevated levels. We will redeploy cash into stocks if better opportunities are present.

As always, we welcome your thoughts and comments.