In the second quarter volatility waned and performance decoupled as divergent backdrops created variances in returns for assets classes and markets across the globe. The winning trades for the second quarter were in the U.S. energy sector, U.S. small companies, and a select group of technology and consumer discretionary stocks. Energy thrived on a rising oil price, small companies on avoiding international earnings exposure, and technology/discretionary on the back of their perceived growth and safety prospects. While U.S. stocks rebounded throughout the quarter, international markets declined, and emerging market stocks were severely punished on the back of a soggier global growth backdrop combined with higher U.S. rates and a stronger dollar. Commodities were a mixed bag, with the energy complex posting big positive returns resulting from favorable supply fundamentals, while the metals and agriculture sectors appeared to succumb to a stronger dollar and other micro fundamental concerns. In fixed income, bonds were volatile but range bound, and very short-term maturities saw moderate returns on the back of continued tightening by the Federal Reserve.
Looking forward investors are challenged with deciding whether these divergent trends will persist, or whether markets are set to recouple as policy burdens build across the globe.
U.S. Tug of War & Rising Global Pressures
Currently major U.S. stock indexes appear to be trapped in a trading range defined by the January 26th high and the February 8th low, while international indexes have recently slipped to new lows on the year. The U.S. has been a relative source of market strength this year and continues to enjoy the residual fruits of the prior tax cuts that are flowing through the economy. But outside the U.S., the overall message of the markets seems to be that a variety of forces are percolating that may act to keep a ceiling on equity valuations for the time being. The combination of cooling global growth, monetary tightening, an increasing risk of a trade policy error, and a challenging seasonal backdrop all appear to be conspiring to prevent stocks from making new highs in the short-term. This has created an environment akin to a tug of war in the U.S., but risks seem to be building and may keep world markets under pressure over the next quarter or so.
2018 Surprise: Less Synchronized Growth
One of the surprises of 2018 has been the downshift in the synchronized global growth story. The simultaneous expansion in global economic growth and earnings was a major driver that helped propel global stock prices higher in 2017. Coming into 2018, that story looked promising to continue, but instead the global economy has run into a soft patch. The U.S. economy got off to a sluggish start in the first quarter, but most signs pointed to a strong acceleration in the second quarter. However, most global economies have experienced recent setbacks, and there doesn’t appear to be any catalysts on the horizon to give them a fresh boost in the near term.
China is the second largest economy in the world and has been slowing, but policymakers there have been taking it in stride, so it’s probably too early to expect a 2015/2016 style fiscal intervention that would pump up growth again. European and Japanese growth rates have also been weaker, with recent headwinds caused by their leverage to overall global growth rates, escalating trade tensions, and the upcoming tapering of bond purchases by European monetary authorities.