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Despite modest losses for the week, S&P 500 gains nearly 7% in June

Nobody buys a farm based on whether they think it’s going to rain next year. They buy it because they think it’s a good investment over 10 or 20 years. – Warren Buffett

The major stock averages closed modestly lower last week as investors nervously awaited the outcome of the meeting between President Donald Trump and Chinese President Xi Jinping at the G-20 summit meeting in Japan over the weekend. Despite the losses for the week, the S&P 500 Index ended the first half of the year with its best performance in two decades while the Dow Jones Industrial Average posted its biggest gain in the month of June since 1938. All of the major averages more than offset the massive losses suffered during May due to increased tariffs and escalating trade tensions with China. While there was ultimately no agreement between the U.S. and China at their meeting, the two sides did agree on a truce with no additional tariffs being imposed. The U.S. had threatened to hike tariffs on an additional $300 billion of Chinese goods. Both countries also agreed to resume negotiations and U.S. companies will be allowed to sell their products to Huawei, the Chinese tech giant, but the company will remain on a trade blacklist. At a minimum, traders received an outcome from the meeting that should not be disruptive to the market – restarting stalled trade talks with no new tariffs being imposed. In economic news last week, the final reading for first quarter GDP came in at 3.1%, the same as the previous estimate. However, the Atlanta Federal Reserve is forecasting less than 2% growth in the second quarter and JP Morgan recently lowered its forecast to just 1.5% growth. The personal consumption expenditures (PCE) index, the Federal Reserve’s preferred measure of inflation, was released on Friday and showed that inflation actually fell to 1.5% in May from 1.6% in April. With benign inflation and markedly slower economic growth on the horizon, it would not be a surprise to see the Fed cut interest rates at its next meeting in July.

Last Week

Durable goods orders in May fell slightly but so-called core capital goods that exclude aircraft rose modestly and was better than expected, suggesting stabilization of business spending. New home sales fell by nearly 8% in May despite a big drop in mortgage rates. Consumer confidence in June fell to its lowest level in nearly two years due to trade tensions with China, job worries and the prospect of slower economic growth. The June University of Michigan consumer sentiment index, however, was slightly better than expected.

Bank stocks were strong last week as the large banks passed their stress tests administered by the Federal Reserve, allowing them to increase their dividends and buy back their stock. In the health care sector, Abbvie agreed to buy Allergan for $63 billion in cash and stock.

For the week, the Dow Jones Industrial Average declined 0.4% to close at 26,600 and the S&P 500 Index dropped 0.3% to close at 2,941. The Nasdaq Composite Index fell 0.3% to close at 8,006.

This Week

The most important piece of economic data this week will be the employment report released on Friday, which is expected to show that about 180,000 new jobs were created and that the unemployment rate remains at 3.6%. Only 75,000 new jobs were created in May, far fewer than expected. Both the ISM manufacturing index and the non-manufacturing or services sector index are expected to decline slightly but still be in expansion territory. May construction spending is expected to increase slightly while May factory orders are expected to decline by about 1%.

The U.S. stock and bond markets will be closed on July 4th in observance of Independence Day and both markets will close early on July 3rd.

There are no notable corporate earnings reports scheduled for this week but second quarter earnings season begins next week.

Portfolio Strategy

Despite the modest losses posted last week in anticipation of the trade talks between the U.S. and China, the major stock averages are still trading near their all-time highs. The Dow Jones Industrial Average and the Nasdaq Composite Index were both up over 7% in the month of June and the S&P 500 Index finished with a gain of 6.9%, capping off its best first half in twenty years. This strong performance has left the benchmark index with a price earnings ratio of 18 times estimated earnings for 2019, compared with an historical average of 15 or 16. Not only are valuations considered rich for equities, but bonds have also soared in price as their yields have plunged. (Bond yields move inversely with prices). The yield on the 2-year Treasury has fallen to about 1.70% while the yield on the 10-year Treasury is now only 2.00%. Even gold, which usually doesn’t perform well when stocks are rising, has caught fire recently and is trading near its highest level in six years. Its dramatic increase has been mostly the result of falling interest rates as inflation remains benign and geopolitical risks remain under control. Real estate investment trusts or REITs have also been excellent performers with a year-to-date total return of over 17%. In other words, all of the major asset classes seem to be trading at levels that exceed their historic averages, making it difficult to find areas of the market that are undervalued or cheap. With the Federal Reserve and the European Central Bank (ECB) both considering easing monetary policy in the face of slowing economic growth and low inflation, valuations of these asset classes could rise further as investors seek to increase their returns.