• While we see some key risks to the economic outlook—mostly centered on confusion over trade policy—we expect this economic expansion will continue.

•  A Fed rate cut on July 31 seems like a foregone conclusion, but we think forecasts for additional rate cuts beyond that are overly optimistic.

•  Investors should expect more limited returns from broad asset classes than they experienced in the past, making selectivity critical.

Equities fell last week with the S&P 500 Index dropping 1.2% (Source: FactSet, Morningstar Direct and Bloomberg). Investor attention was focused on the Federal Reserve, as one Fed official seemed to indicate the possibility of a 50 basis point rate cut next week before that statement was walked back to make it clear that a 25 basis point cut was more likely. For the week, consumer staples, technology and health care led the way while communications services, energy and consumer discretionary lagged (Source: FactSet, Morningstar Direct and Bloomberg).

Despite Downside Risks, We Expect The Economic Expansion To Continue

At this point, the United States has enjoyed the longest economic expansion in its history. But it often doesn’t feel like it since investors appear to be mostly focused on some of the key downside economic risks. Chief among those are the slowdown in manufacturing, trade issues and broader domestic and global political dysfunction.

A slowdown in both manufacturing and trade levels around the world has been a persistent source of concern. Starting last year, we have seen ongoing confusion and consternation over global trade policy, and especially over President Donald Trump’s volatile approach to threatening tariffs and moving in and out of negotiations with other world leaders. We view the mounting trade pressure from the U.S. as a threat to the global economy. The recent G-20 meeting was mildly positive, with the U.S. delaying another round of tariffs on Chinese goods and temporarily relaxing restrictions on Huawei. By itself, however, the outcome does not remove the overhanging threat to global growth. This was reinforced by the U.S. announcement of new, albeit small, tariffs against European goods.

As long as trade policy remains uncertain, corporate management teams will be reluctant to engage in new spending plans and capital investments, which has dampened manufacturing data. To some extent, we think the manufacturing slowdown is cyclical and has been caused in part by the lagged effects of Federal Reserve rate hikes that took place in 2018. We do expect to see a pickup in manufacturing by the end of the year, but also think trade-policy confusion will remain a drag on economic growth until at least the 2020 elections.

While trade is certainly the headline issue affecting investor sentiment, we are also concerned with a range of other U.S. and global political issues that could be problematic for the economy and financial markets. Political discord in the U.S. is growing. The risks of some sort of fiscal showdown this fall over the budget and debt ceiling are rising and ongoing investigations into the Trump Administration could well trigger additional uncertainty. Investors are also anxiously awaiting the 2020 election and what the results could mean for tax and regulatory policies. Globally, we’re also focusing on the growing prospects for a messy Brexit as well as potential flare ups in the Middle East and on the Korean peninsula.

Nevertheless, we remain cautiously optimistic that the expansion will continue. The labor market remains strong, consumer spending is solid and the Federal Reserve remains highly accommodative—more on that point in the following section. Especially if global manufacturing picks up, we think the slow expansion will continue and do not see the sorts of imbalances that would trigger a recession.

We Expect The Fed Will Ease, But Not As Much As Markets Anticipate

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