The Mid-Year Update presents a follow-up to our annual view published last December and affords a chance to make adjustments, if necessary, for what we expect to come during the remainder of the year.
Seeing the picture when the view is less than clear
- Economic growth will remain positive, extending this record expansion well beyond this year, supported by a healthy level of consumption.
- Volatility will remain high until there is a market-satisfying Sino-American trade detente, or evidence emerges of an uptick in global economic conditions.
- Stocks have covered meaningful ground already this year, but the advance can continue if the macro landscape becomes more predictable.
- Fixed income markets had a strong first half, goosed by falling interest rates, low inflation expectations, and a benign monetary setting.
- The rapid decline in rates, however, may have overshot monetary expectations and the current phase of the economic cycle.
- Near term, there is potential for a backup in interest rates, but while a Federal Reserve rate cut is possible in 2019, up to four cuts in 2020 are more likely.
- We continue to recommend an up-in-quality bias, particularly in corporate bond markets where spreads are overly narrow relative to the risk.
- Given the stage of the credit cycle, high yield corporate bonds in particular appear to offer a poor risk/reward tradeoff.
- Below-average primary supply and steady demand, including a record pace of inflows to tax-free mutual funds, have supported strong municipal performance.
- With a tailwind from stronger-than-expected April tax collections, credit spreads of even fiscally stressed states—such as Illinois, Connecticut and New Jersey—are the tightest of the year.
- While restructuring efforts for Puerto Rican municipal debt are underway, the path is muddled by complicated litigation and court decisions.
- The outcome from the Puerto Rican debt settlement negotiations could have a broad and potentially negative impact on the public finance marketplace.
Economy & Equity Markets Outlook
Mark Luschini, CMT, Chief Investment Strategist
Much of what we expected has evolved in a fashion that requires little change from those views expressed six months ago. The economy has slowed somewhat, but remains on a positive track. This has enabled the Federal Reserve (Fed) to elicit a more dovish posture and patiently allow data to accumulate to shape future decisions around the appropriate monetary setting. In turn, the equity market has responded favorably and bond yields have drifted lower. To be sure, the risks associated with trade wars and other geopolitical tensions have not receded, which means volatility will remain heightened and the possibility of bimodal outcomes keeps our confidence interval unusually wide.
Fixed Income Market Outlook
Guy LeBas, CFA, Chief Fixed Income Strategist
It is summer in the northern hemisphere, so flip-flops are a given. However, the flip-flops the dominant economic and financial market narratives have gone through during the past several months are truly something to behold. From panic in late December to euphoria in early April to a bizarre sort of in-between today, these narratives have driven some wild moves in the level of interest rates in particular.
Strong investor demand for tax-free income fueled significant municipal market outperformance during the first half of 2019.
Mutual funds, key beneficiaries of this investor interest, gained more than $40 billion of new cash in an uninterrupted stream of weekly inflows, and municipal bond exchange-traded funds (ETFs) accounted for an additional $3 billion in the strongest annual start on record. Municipal new issue supply set no such records.