Domestic equity markets finished the month positive after the Fed met investor expectations by cutting the Federal Funds Rate by 25 basis points on July 31. The S&P 500 finished positive by 1.44%. The Fed’s move had been confidently anticipated since Fed Chairman Powell’s comments earlier in the summer turned significantly more dovish. The Fed also announced that it would cease its balance sheet reduction (which was another tightening measure) at the end of August, two months earlier than previously planned. Markets sold off following the actual announcement, in large part due to the fact that the positive returns had already taken place but also due to Powell’s press conference in which he seemed to indicate this rate cut was a one-off and not the start of a cutting trend. He also struggled to justify a rate cut without making the economic outlook sound too tenuous. Interest rates were largely unchanged across the yield curve for the month, again because the Fed’s actions on July 31 were expected since early June. Trade talks between the U.S. and China resumed on July 30 as well; this is the first meeting between officials since the tariff ceasefire agreed upon by Trump and Xi at the G-20 summit in June. Expectations for progress are muted. Trump and other officials have suggested that the Chinese are intentionally dragging out the negotiations until the presidential election in the hope that Trump will lose and a softer negotiating partner may be elected.

Corporate earnings season is well underway. As of July 26, 44% of companies in the S&P 500 had reported results for the second quarter. Overall, the outcome has been better than expected. According to FactSet the blended earnings forecast (combining those that have already reported with the estimates for those that have not) was -2.6% year-over-year, compared with -3.4% forecasted as of July 19. Still, Q2 will likely mark the first time we’ve seen two straight quarters of earnings decline since the first half of 2016. The decline can largely be attributed to companies that have more global exposure, which have been feeling the pressure of trade tensions, slowing global growth and the headwinds that come with a relatively strong dollar. FactSet reports that the blended earnings forecast for S&P 500 companies that have more than 50% of revenues coming from outside the U.S. is a -13.6% decline year-over-year.

What we find remarkable is that despite the struggles of companies with a global reach, which tend to be part of the large market cap asset class, large cap stocks continue to outperform mid- and small- cap stocks. This is the case not only in July but also year-to-date and over the trailing 12 months. The 12 month returns of the S&P 500 (large cap) and the S&P 600 (small cap) indexes as of the end of July are, respectively, positive 7.99% and negative 6.75%. The fact of large cap’s outperformance in this difficult global environment is surprising in and of itself, and the degree to which it’s outperforming makes it more so. It’s important to remind investors that despite the S&P 500’s dominance for the lion’s share of this current economic cycle, it remains crucial to keep exposure to the mid and small sized companies in the U.S. because outperformance of large caps is unlikely to last forever.

Pressures weighed on international markets, both developed and emerging. In Britain, Boris Johnson was elected to lead the Conservative Party and thus became the prime minister. Johnson, whose political stripes have changed significantly over the course of his career, is best known for his advocacy for Britain to leave the EU during the Brexit campaign. He will now lead the effort to navigate Brexit. Johnson’s initial approach appears predicated on a “no-deal” Brexit in which Britain leaves the EU without establishing a new trade regime. This may be Trump-style bluff aimed at getting the EU to compromise, but either way it has investors concerned as a no-deal Brexit is seen as a bad outcome for all those involved.

With the financial news event of the summer—the Fed’s rate cut—now behind us, it will be interesting to see what drives market returns over the next few months. If corporate earnings continue to outperform expectations, if U.S.-China trade talks don’t take a turn for the worse, and if the market doesn’t determine an additional rate cut is necessary this year, it is certainly possible that markets could continue to melt higher, but overall we believe the risk is to the downside. The best return of the S&P 500 in a calendar year during this economic cycle was in 2013 when the index returned 32.39%. That we are on pace to surpass that in the 10^th year of a bull market should cause readers and investors to temper their expectations about returns during the remainder of the year. While we never advocate trying to time the market, if you have been reassessing your risk tolerance lately then it may be prudent to make portfolio changes now while volatility is low.

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