Second Quarter 2019 Equity Commentary

Published on Jul. 15, 2019

Second Quarter 2019 Equity Commentary

Stocks closed out the 2nd quarter in robust fashion, lifting the S&P 500 to about a 4.3% gain for the period. Investors were encouraged by the resumption of trade negotiations between the US and China. While we believe a decelerating global growth profile may present challenges for markets, central banks are doing their part in order to help stimulate economic activity.

The trade war between the US and China continued to be a focal point for investors during the 2nd quarter. Circumstances appeared to be deteriorating in recent weeks after the Trump administration put Huawei and a handful of other Chinese companies on an export blacklist. However, at the recently completed G20 summit, the two countries agreed to resume negotiations and forestall any further tariffs. Huawei was granted exceptions which will enable the company access to certain US technologies, and in a show of good faith China will resume purchasing American agricultural goods. While it remains to be seen whether a successful trade agreement will ultimately be reached, things appear to be moving in a favorable direction, at least for the moment.

We believe recent datapoints appear to confirm that global economic conditions are weakening. Surveys of both the Chinese and European manufacturing sectors have been flagging in recent months. Markit, which conducts purchasing manager surveys, noted that its measure of European economic optimism is at its lowest level since 2014. While we have been concerned with international economic conditions for some time now, it appears that domestic growth may also be weakening. After a 1st quarter which saw GDP growth in the US surpass 3%, consensus estimates are projecting a 2nd quarter deceleration with most forecasts in the 1-2% range. While the service sector appears to be holding up relatively well, manufacturing has been somewhat challenged, perhaps due to increased uncertainty related to tariffs and trade. The June manufacturing PMI decelerated to 50.1, a level indicative of stagnating growth. The June composite PMI, which aggregates the service and manufacturing sectors, came in at just 50.6, its weakest reading in over three years.

As a result of these uneven economic conditions, central banks around the world are becoming increasingly dovish. In its latest meeting, the Federal Reserve acknowledged various issues including U.S.-China trade uncertainties, feeble inflation, and soft international markets. Fed Chairman Powell noted that many FOMC members now see a stronger case for easing policy. We believe that many investors were already anticipating multiple rate cuts during the 2nd half of the year, and it now appears that the Fed’s view is more closely aligned with these market expectations.

The European Central bank has already taken stimulative action with the latest round of its TLTRO (targeted long-term refinancing operations) program attempting to spur lending across the region. While we are optimistic that central banks are taking steps towards shoring up their respective economies, global growth remains a key risk factor in our view. In addition to monetary policy, we think that a successful trade agreement between the US and China would go a long way towards improving global economic sentiment and business conditions.

We have recently implemented two new themes into our portfolios, ‘5G’ and ‘Cannabis’. We believe 5G, the next generation of wireless communication standards, is a game-changer. It offers the potential for much faster speeds, higher throughput, lower latency, and greater density of connected devices. This should support new use cases, possibly including fixed wireless access, smart homes, the “Internet of Things”, advanced driver-assistance and augmented reality. Importantly, national security concerns have catalyzed a global race to adoption. We see potential winners across the supply chain, from infrastructure suppliers to application developers.

The burgeoning market for legal cannabis in both the US and Canada has prompted a wave of companies to raise capital in order to take advantage of this emerging growth opportunity. In recent years, nearly half of U.S. states have legalized cannabis for medical or recreational use. Consumer packaged goods companies are rapidly getting up to speed on how cannabis derivatives might be used in food and beverage or health and wellness products, with some of the largest players acquiring stakes in publicly-traded Canadian companies to try and gain an edge in this regard. The pharmaceutical sector is also investigating therapeutic uses of cannabis-derived compounds, and a few have already been approved by the FDA. We believe this phenomenon is in its early stages, and we expect that the companies which successfully position themselves could see meaningful growth opportunities for years to come.

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