Stocks and Bonds Lifted by Rate Cut Optimism
In the wake of the Fed’s announcement of a new policy objective—to “sustain the expansion”—U.S. Treasury and stock markets approached record highs in the second quarter, and the 10-year U.S. Treasury yield hit a multi-year low.
The S&P 500 Index rose 4.3%, bringing its year-to-date return to 18.5%. Financials (+8.0%) were the best performers while Energy (-2.8%) was the only sector with a negative return. Small cap stocks (Russell 2000: +2.1%) underperformed large (Russell 1000: +4.2%) and growth continued its trend of outperformance across the capitalization spectrum, albeit only modestly in the second quarter. In a reversal from the first quarter, quality factors such as operating margin and return on equity contributed to performance. Value factors (P/B, P/E trailing, and yield) were mixed while growth factors (EPS growth, sales growth) were positive.
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Developed markets were also buoyed by optimism for rate cuts. The MSCI ACWI ex-USA Index rose 3.0%, with Canada (+4.9%), Pacific ex-Japan (+5.2%), and Europe ex-UK (+5.8%) leading the way. Japan (+1.0%) and the U.K. (+0.9%), at the lower end of the group, were able to eke out small positive returns. The Canadian dollar, yen, and euro appreciated versus the U.S. dollar while the British pound and Australian dollar lost ground. Emerging markets (MSCI Emerging Markets Index: +0.6%) underperformed developed but returns across countries varied. Argentina (+31.7%) was the best-performing country, with political developments boosting sentiment; Russia (+16.9%) was also a strong performer. China (-4.0%) finished in negative territory, but the market was able to recover after May’s sharp pull-back thanks to the pause in tariff hikes following the G20 Osaka summit. Also worth mentioning is the performance of the two other BRICs; Brazil (+7.2%) and India (+0.5%). The U.S. dollar weakened versus most emerging market currencies as the prospect for rate cuts in the U.S. loomed large.
Fixed Income Markets
In the U.S., the Bloomberg Barclays US Aggregate Bond Index rose 3.1% for the quarter, nearly mirroring its first quarter result (+2.9%). U.S. Treasury yields hit multi-year lows in June, and the 10-year closed the quarter at 2.0% (the lowest since November 2016). The curve remained inverted between the 90-day T-bill and the 10-year U.S. Treasury, but the more widely watched spread between the 2- and 10-year widened during the quarter to 25 basis points. Investment grade corporate bonds performed best (+4.5%). Agency mortgages underperformed (+2.0%) as lower rates raised concerns around prepayment risk. TIPS (Bloomberg Barclays TIPS: +2.9%) underperformed as inflation expectations fell; the 10-year breakeven spread was only 1.69% as of quarter-end versus 1.88% as of March 31. The high yield corporate bond market (Bloomberg Barclays High Yield: +2.5%) underperformed investment grade but is up nearly 10% YTD. Leveraged loans (S&P LSTA: +1.7%) held their own in spite of negative press and falling rates. Municipal bonds (Bloomberg Barclays Municipal Bond: +2.1%) underperformed U.S. Treasuries in the second quarter.
Overseas, yields across developed markets generally fell. The Bloomberg Barclays Global Aggregate Bond Index rose 3.3% for the quarter on an unhedged basis. Hedged into dollars, the Index gained 2.9%. In a reversal from the first quarter, the dollar lost ground vs. most currencies, with the pound being a notable exception. In Germany, the yield on the 10-year government bond hit an all-time low and closed the quarter at -0.33%. Negative-yielding debt globally hit a new high of nearly $13 trillion and is now roughly 25% of the Global Aggregate Index. Emerging market debt performed well; the U.S. dollar-denominated JPM EMBI Global Diversified Index gained 4.1%. Local currency emerging market debt, as measured by the JPM GBI-EM Global Diversified Index, rose 5.6%.
The Bloomberg Commodity Index fell 1.2% in the second quarter. Both the Precious Metals (+7.2%) and Agriculture (+4.5%) commodity sectors were positive performers, driven by strong individual returns for gold (+9%) as well as corn, wheat, and coffee. Meanwhile, the Livestock, Energy, and Industrial Metals commodity sectors all posted negative quarterly results. Oil pulled back but was roughly flat for the quarter, ending at $58/barrel (West Texas intermediate), while natural gas within the Bloomberg Energy Sub-index declined a precipitous 16.2%. Elsewhere, MLPs (Alerian MLP Index: +0.1%) were flat and REITs saw modest gains (FTSE Nareit Equity: +1.2%) but lagged listed infrastructure assets (DJ Brookfield Global Infrastructure: +4.3%).