Pennsylvania Trust

Mixed Messages

Photo of George McFarlandQ2 Recap

The U.S. stock market rallied strongly in the second quarter, with the S&P 500 advancing by 3.4% on a total return basis. Underlying the advance was a strong domestic economy and robust corporate earnings. Of the eleven sectors in the S&P 500, energy turned in the best quarterly performance (up over 12%) as the price of domestic crude oil rose by 14% to $74 per barrel, a high since November 2014. Industrials, hurt by concerns over slowing global growth and trade war uncertainties, had the worst performance (down over 3%). By style, just as in the first quarter, small cap stocks outperformed large cap stocks, while growth stocks outperformed value stocks.

International stocks, overall, as measured by the MSCI World Index, ex-U.S., did relatively poorly during the second quarter, declining by 0.7%. Emerging market stocks, of note, fell approximately 8%. Strong U.S. dollar performance (up over 5% during the quarter as measured by the Wall Street Journal Dollar Index) contributed to this sharp decline.

The U.S. bond market was relatively flat during the quarter. The overall U.S. investment grade taxable bond market, as measured by the U.S. Barclays Aggregate Index, declined by a modest 0.1%, while the overall investment grade U.S. municipal (tax exempt) bond market rose slightly. As with stocks – international bonds and particularly emerging market bonds, fared more poorly.

Market Returns at Mid-Year

Year to date, through June 30th, the S&P 500 rose 2.65% on a total return basis. Only three sectors did better than the overall S&P 500: consumer discretionary (up 12%); technology (up 11%); and energy (up 7%). Of the eight sectors underperforming the S&P 500, consumer staples was the worst performer (down over 8%).

Two equity themes were on display during the first half of the year. The first was the outperformance of small cap stocks, which are largely insulated from trade war concerns due to their domestic revenue focus and stand to benefit the most from the corporate tax reforms passed late last year. The small cap S&P 600 Index rose by 8.8% on a total return basis in H1, while the small cap Russell 2000 Index rose by 7%, dwarfing the S&P 500’s return. The second theme was the dramatic outperformance of growth stocks over value stocks. The Russell 1000 Growth Index, for example, gained 7.25% while the Russell 1000 Value Index lost 1.7%.

Growing doubts about global growth prospects served to dampen international stock market returns during the first half of the year. Year to date through June 30th, emerging market stocks were off over 6%, while developed international stocks were down over 2%.

Given the generally rising interest rate climate during the first half of the year, U.S. bonds turned in a slightly negative performance, with the Barclays Aggregate Index off 1.6%. Shorter term bonds held up better than longer term bonds, while high yield did a bit better than investment grade.

What’s Next

The third quarter is generally recognized as a seasonally weak period. Indeed, since 1928, the months of July through September, on average, have produced the worst – though still positive – quarterly returns for the S&P 500. As we have said before, it is a near certainty that volatility will increase over the months ahead. This is a natural result of the mixed messages that are confronting investors.

There are several positive messages for U.S. equities. One is the still very healthy U.S. economy. The housing, manufacturing, and services industries remain strong. Unemployment is near record lows and consumer confidence remains near record highs. Economists expect Q2 real GDP growth to be about 4% and full year growth to be about 3%. Another critical tailwind for domestic equities is the strong earnings performance being reported by the companies in the S&P 500. As in the first quarter, S&P 500 earnings are anticipated to rise about 20% in the second quarter and, indeed, for the full year as well. Thanks to the S&P 500 still trading about 5% off its late January peak, valuations are reasonable at 16 times forecasted earnings.

On the negative side, there are more than a few potential headwinds – especially for global equities. Chief among these concerns is what appears to be slowing economic growth in Europe, China, and elsewhere. This growth will only be further challenged by trade wars should they develop. Domestically, the major worry over the next 12-18 months involves the future path of rate increases by the Federal Reserve. As expected, the Fed increased interest rates in June and may do so again in September and December. Of note, inflation is slowly rising and has now reached the Federal Reserve’s target of 2%. Should inflation rise materially above that level, and stay above that level, the Federal Reserve likely will feel compelled to continue to raise rates more than the market currently expects. As we head deeper into summer, another headwind facing domestic equities will be the uncertainty over the mid-term election results come November.

How should investors react to these mixed messages? Focus on high quality, profitable companies with strong balance sheets, and the ability to generate strong cash flow. Besides this, having a well-diversified portfolio is very important, including an allocation to fixed income where appropriate. Above all, it is critical to maintain a long-term perspective. In this regard, the most significant fact to be aware of is that the S&P 500 was up over 3% on the first day of summer this year.* This is worthy of note because every time this has happened since 1950, the S&P 500 has finished the year with gains.

  • Year
  • 1951
  • 1952
  • 1954
  • 1955
  • 1958
  • 1959
  • 1961
  • 1963
  • 1964
  • 1967
  • 1968
  • 1971
  • 1972
  • 1975
  • 1976
  • 1979
  • 1980
  • 1983
  • 1985
  • 1986
  • 1987
  • 1988
  • 1989
  • 1991
  • 1995
  • 1996
  • 1997
  • 1998
  • 1999
  • 2003
  • 2007
  • 2012
  • 2013
  • 2014
  • 2017
  • 2018
  • YTD Return as-of 6/20
  • 7.2%
  • 3.4%
  • 17.0%
  • 11.6%
  • 12.2%
  • 3.5%
  • 12.1%
  • 11.0%
  • 7.8%
  • 15.1%
  • 4.2%
  • 7.7%
  • 6.5%
  • 35.1%
  • 15.0%
  • 5.7%
  • 5.7%
  • 20.2%
  • 11.7%
  • 17.4%
  • 26.8%
  • 8.8%
  • 15.7%
  • 13.7%
  • 18.7%
  • 7.5%
  • 21.3%
  • 13.4%
  • 9.2%
  • 13.2%
  • 6.7%
  • 7.8%
  • 11.4%
  • 6.2%
  • 8.9%
  • 3.5%
  • S&P 500 Return Rest of Year
  • 8.5%
  • 8.1%
  • 23.9%
  • 13.3%
  • 23.1%
  • 4.8%
  • 9.8%
  • 7.2%
  • 4.8%
  • 4.3%
  • 3.3%
  • 2.9%
  • 8.7%
  • -2.6%
  • 3.6%
  • 6.2%
  • 19.0%
  • -2.4%
  • 13.1%
  • -2.3%
  • -19.5%
  • 3.3%
  • 10%
  • 11.1%
  • 13%
  • 11.9%
  • 8.0%
  • 11.7%
  • 9.4%
  • 11.7%
  • -2.9%
  • 5.2%
  • 16.4%
  • 4.9%
  • 9.7%
  • S&P 500 Full Year Return
  • 16.3%
  • 11.8%
  • 45.0%
  • 26.4%
  • 38.1%
  • 8.5%
  • 23.1%
  • 18.9%
  • 13.0%
  • 20.1%
  • 7.7%
  • 10.8%
  • 15.8%
  • 31.5%
  • 19.1%
  • 12.3%
  • 25.8%
  • 17.3%
  • 26.3%
  • 14.6%
  • 2.0%
  • 12.4%
  • 27.3%
  • 26.3%
  • 34.1%
  • 20.3%
  • 31.0%
  • 26.7%
  • 19.5%
  • 26.4%
  • 3.5%
  • 13.4%
  • 29.6%
  • 11.4%
  • 19.4%
Source: FactSet
Note: Annual returns reflect the compounding of pre- and post-solstice returns.

So, even if we have a choppy third quarter, if history repeats, we should finish the year with at least modestly positive returns. This forecast is further bolstered by the other historical fact (noted in our June 6, 2018 commentary) that since 1950 the S&P 500 has never declined in the 12 months following the November mid-term elections.

As always, we encourage you to reach out to us with any questions, concerns, or perspectives you may have. Please contact your portfolio manager, or you may reach us at 610-975-4300, or email info@penntrust.com.

Mr. McFarland is President, Chief Executive Officer, and Chief Investment Officer of Pennsylvania Trust.


*In the Northern Hemisphere, the first day of summer varies from June 20-22. This year, the date was June 21.

Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome – including performance – is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.