Equities are on pace for their best year of this expansion, and despite compounding uncertainties as we hit the halfway mark in 2019, realized volatility is below historical averages. Stellar returns have largely been fueled by the Fed’s significantly dovish pivot, however. A perfect storm of policy uncertainty is brewing, and we expect volatility to reemerge in the second half of the year.
Equity markets are first and foremost challenged by diminishing fundamentals. Corporate profits fell 2.8% in Q1, the largest quarterly drop since 2015, reflecting, in part, decelerating economic growth. Trade tensions have also had a significant effect on U.S. earnings. Companies with a high percentage of revenue generated from foreign countries have seen earnings per share (EPS) drop over the past year, while companies with domestically derived revenue saw earnings rise.
Beyond moderating growth is a long list of policy uncertainty that we expect to stoke volatility. While investors have hope for a U.S.-China trade agreement, we see trade tensions as a genie that will not easily return to the bottle. Recently, it was the unexpected threat of tariffs on Mexico that caused volatility to spike in early May. This was quickly soothed by markets pricing in an additional 55 bps of rate cuts by the end of 2019. But relying on Fed rate cuts carries its own risk: The Fed may not ease as much as markets expect. Even the most dovish Fed official is well short of some market participants calling for four rate cuts.
There are factors supporting equity markets as well. Record-high stock buybacks continue with no sign of slowing and could very well continue to bolster equity valuations in the short to medium term. With uncertainties lining up on both sides, we see higher volatility as the most likely scenario during the second half of 2019.
Read the analysis for each indicator:
This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.
Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.
All investing is subject to risk, including the possible loss of the money you invest.