Key Takeaways
• The S&P 500 delivered its best first-half performance since 1997, raising questions about what that strong start may mean for the second half.
• Stocks’ track record after the strongest first-half rallies is mixed but points to modest gains ahead.
• We would consider this bull market to have a stronger foundation if it had more sustained leadership from cyclical sectors and relied less on central bank policy.
Even after such a strong first half of this year, we think stocks may have more left in the tank. The S&P 500 Index gained 17.4 percent during the first half of 2019—an excellent performance—even though a decent chunk of those gains reversed the 2018 fourth quarter losses. Putting that six-month performance into perspective, it was the best start to a year for the stock market since 1997, and its tenth-best start since 1950. This week we recap the first half and analyze prior strong starts to see what we might expect in the second half of 2019.
First-Half Recap
The main drivers of the strong first half were the Federal Reserve’s (Fed) U-turn on monetary policy and progress on trade. The Fed’s reversal helped not only the market’s expectations for the U.S. economy but also supported stock valuations by pushing interest rates lower.
Even with the S&P 500 at record highs and a less rosy corporate profit growth outlook due to tariffs and trade uncertainty, the forward price-to-earnings ratio (P/E) for the index is still only 17, as of July 3, 2019. At that valuation, with such low interest rates, stocks look more enticing relative to bonds. The latest move in the 10-year Treasury yield below 2 percent—its lowest level since November 2016—was driven by President Trump’s recent nominees to the Federal Reserve Board, who are expected to favor lower rates, and expectations that Christine Lagarde, current head of the International Monetary Fund (IMF), will carry on Mario Draghi’s preference for lower rates as the new head of the European Central Bank.
Although progress on trade has been uneven, the United States and China came close to an agreement in April before talks derailed, fueling optimism that a more comprehensive deal to reduce or eliminate tariffs may be coming this fall. President Trump and China’s President Xi have since resumed negotiations after the Trump administration removed the latest tariff threat, adding to the optimism. Removing the tariff threats from Mexico and Europe (mainly on autos) was also well received by markets.
Looking ahead, the Democrats may delay ratifying NAFTA 2.0 (the United States-Mexico-Canada Agreement, or USMCA) until after the 2020 election, and the Trump administration could slap tariffs on European autos this fall. These concerns didn’t stop stocks from hitting more new highs last week but remain on our radar.