In spite of the usual seasonal slowdown in financial activity, it has been a very eventful midsummer for investors. Financial markets and policymakers have both reacted to softening fundamentals and increased trade policy uncertainty with small but notable reversals. Stock prices fell somewhat and bond yields fell more sharply (prices rose). More eventfully, the Federal Reserve eased monetary policy with an “insurance cut” to the short-term interest rate target, so-called because from their perspective the economy appears fine at the moment, but is at risk of deteriorating due to the slowing international economy, which largely has not benefited from fiscal stimulus, and also to rising trade tensions, which threaten to offset the current tailwind of tax cuts in the US.
It is unusual for the Fed to cut interest rates while unemployment is low and inflation is on target, but the continued drop in bond yields shows that market participants expect more cuts to come. Indeed, with the benefit of tax cuts fading, there are already signs the US is not immune from the global slowdown. Economists’ estimates of 2019 GDP growth and capital investment have softened. Job growth has clearly slowed from last year. The S&P 500 Index, most members of which are US-based multinational businesses, just reported a second consecutive quarter with scant earnings growth.
While we are taking all these factors into account, a grain of salt is also due. The economy is still in solid shape, and easing policy might provide a noticeable boost. Many companies are doing extraordinarily well, growing and generating strong cash flow. Market valuations cannot rise inexorably, but strong businesses should offer some combination of growth and safety as uncertainty persists.
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