Short-term Pullback Appears Likely

July 10, 2019

07-03-2019 BuyLine

Another short-term pullback appears likely given daily trading indicators are again overbought and turning down following the June-July rally that pushed major US equity indices to new highs last week. Profit-taking heading into Powell’s testimony this week and the beginning of earnings next week would not be surprising, but as always, we recommend investors remain focused on two key investment horizons. The first is the intermediate-term, multi-month perspective, which is in the early stages of turning positive following a temporary Q2 pullback. Second, and more importantly, the longer-term, bullish cycle backdrop continues to build positively from the cycle low established in Q4 2018. This cycle could possibly cause a tailwind for equities through the second half of 2019 and well into 2020.

07-03-2019 SP


What a difference six months can make. Late last year, financial markets were worrying the Federal Reserve (“the Fed”) was tightening into a global and U.S. economic slowdown. As the calendar turns to July, central banks are in the midst of the most dovish rotation in years. The Fed is preparing the markets for a rate cut at its July 30- 31 meeting. Globally, 58% of central banks’ latest rate changes have decreased. The prospects for lower short-term rates and slower growth pushed the 10-year Treasury yield to 2%, a 33-month low.

As a result, the bond market saw a stellar performance in Q2. The Barclays Global Aggregate Total Return Index gained 3.37%, the best quarter since Q1 2016. Every major fixed income aggregate posted a positive total return. Moreover, every index recorded a gain except for three small Asian-Pacific credit indexes. Given the drop in yields, it was not surprising that the longest duration bonds had the best performance. With a modified adjusted duration of 18 years, Long-Term Treasury Bond prices gained 5%.

  • Credit also performed well. U.S. investment-grade corporates, which was up 13% also has a relatively long duration of 7.5 years and took the second-best spot, gaining nearly 4.5%.
  • Global credit returned just under 4.0%.
  • Year-to-date, U.S. investment grade and high yield bonds have had nearly identical returns of just under 10%.
  • The June Fed meeting showcased a bimodal Fed, which opened the door to rate cuts.
  • Investors are now widely expecting a rate cut at the next Fed meeting, slated for July 30-31.

The global economy remains in a sustained slowdown. The intensification of the trade war to already fragile conditions was evident in the June economic data. The good news is, the U.S. doesn’t appear to be anywhere close to a recession. While growth is expected to slow down to about 2.3%, it is merely returning to trend, following an outsized boost from the 2017 tax cuts. Additionally, inflation remains at record low levels, which is good for stock and bond performance. Accordingly, the bond market correctly anticipated the first Fed rate cut. Long-term Treasury yields have fallen in every case back to 1970 in the months leading up to the first rate cut. Bond prices tend to bottom 2-3 months before the rate cut and stabilize after the rate cut. Bond sector results were more mixed following the first cut.

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