2019 First Half Review and Outlook

by | Jul 11, 2019 | Quarterly Reviews

The S&P 500 index overcame increased Chinese tariffs, threats of Mexican tariffs and a slowing economy to finish the second quarter up 4.6%. For the first half of the year the S&P 500 index returned 19.56%. At Virtue Asset Management, we believe the S&P 500 is close to fairly valued. The one-year Treasury bond is yielding approximately 2%. We believe equities will provide returns better than the bond market over the next six to twelve months. We expect increased volatility in equities and recommend most clients to stay at a neutral equity weighting. We recommend that investors match upcoming cash flow needs, including required minimum distributions, with high quality bonds that mature at the time of the cash flow needs. This strategy will protect the overall portfolio from selling equities at a lower price if we experience the increased volatility we expect.

On May 10th, President Trump raised tariffs from 10% to 25% on $200 billion of Chinese imports. On May 31st, President Trump announced 5% tariffs on all goods imported from Mexico for a failure to take action on the illegal migration crisis. The unexpected announcement of the Mexican tariffs was more of a shock to the market then increasing the Chinese tariffs. The market understands that the tariffs on China are part of negotiations but are worried when tariffs are applied to other countries at the whim of the president. This uncertainty makes it harder for businesses to plan future investments.

Fortunately, on June 4th, Federal Reserve chairman Jerome Powell said that the central bank was prepared to act to sustain the economic expansion if President Trump’s trade war weakened the economy. Traders took this as a green light to purchase US Stocks and these comments helped give traders the confidence that the Federal Reserve would cut rates to continue the economic expansion. Since Powell’s comments the S&P 500 index has returned approximately 7%. This led to a strong return for the S&P 500 index for the second quarter.

The S&P 500 Growth Index returned 4.56% for the second quarter compared to the S&P 500 Value Index which returned 4.02%. For the first half of the year the S&P 500 Growth Index returned 21.33% and the S&P 500 Value Index returned 17.60%. Most equity asset classes showed strong returns, the S&P Mid-Cap Index returned 3.05% for the second quarter and has returned 19.18% for the first half of the year. The S&P Small Cap Index returned 1.87% for the second quarter and has returned 19.34% for the first half of the year.

United States equities continue to outperform the rest of the world. International equities, as measured by the MSCI EAFE Index returned 3.75% for the second quarter and returned 14.59% for the first half of the year. Emerging markets, as measured by the MSCI Emerging Markets Index returned .48% for the second quarter and returned 10.57% for the first half of the year. Given the lower economic growth expectations of Europe and the unknown consequences of Brexit, we continue to recommend overweighting US Equities versus International Equities. We recommend underweighting exposure to Emerging Markets due to a slowing Chinese economy combined with the ongoing trade negotiations.

One investment strategy that traders have utilized is buying equities with a high valuation based on the price to earnings ratio (P/E). This ratio is calculated by dividing the current price of the stock by the last twelve-month earnings. In the S&P 500 they are 475 companies that have positive earnings. We created five groups based on their P/E ratios. The 95 stocks with the highest P/E ratio in the S&P 500 (with a median P/E of 55) returned 25% year to date. The 95 stocks with the lowest P/E ratio in the S&P 500 (with a median P/E of 11) returned 12% year to date.


Breaking the S&P 500 into P/E Quintiles
Groups Average P/E Median P/E Avg Return Year to Date


143 55



















When investing in any company, we like to imagine we’re becoming an owner of the company. We’re trying to predict future cash flows and decide the risk of buying the company given the current price of the stock. The higher the P/E valuation of the stock, the more likely investors are predicting rapid growth in future earnings. No investor should pay 55 times recent earnings unless they expect the company to grow earnings at a rapid and sustained pace. The problem with these expectations is that it only takes a small bump in the road to drastically change the path of future earnings. One of the best-known high valuation stocks is Tesla. In 2018, Tesla was the world’s bestselling plug-in passenger car. However, Tesla still has negative earnings. Tesla has a market capitalization of approximately 40 billion with negative earnings. In 2019, concerns about competition and Chinese tariffs have weighed on Tesla’s stock. At its highest point in the last year, the stock had an approximate 70 billion market cap. This high-flying stock is down over 40% from its high price.

Our philosophy at Virtue Asset Management is to focus on investing and not short-term trading. For short term traders, a risky strategy is to buy high valuation stocks because they should perform better in a bull market and an environment where expectations are the Federal Reserve will significantly cut rates to insure economic growth. These short-term positive trends have been known to reverse. The Federal Reserve was unable to stop the significant market pull backs experienced after the dot com bubble and real estate bubble. We feel it is important to understand the risk/reward of a portfolio. A portfolio that is 100% equities but composed of lower P/E stocks may perform better in a significant pull back compared to a portfolio that is 60% of high P/E stocks. We recommend customized portfolios to match the risk/reward of each client.

The Atlanta Fed has a forecasting model that is a running estimate of real Gross Domestic Product (GDP). The current estimate for the second quarter real GDP is 1.5%. If correct, this would be a significant pullback from the first quarter real GDP of 3.1%. In May, nonfarm payrolls increased by only 75,000 workers and the previous two months were revised lower by 75,000 workers. However, the unemployment rate remained at a 50-year low of 3.6%. These lower economic numbers have led to a narrative of a slowing US economy. Fortunately, in June the nonfarm payrolls increased by 224,000 jobs and the unemployment rate rose to 3.7%.

At the beginning of the year the market was forecasting a 34% chance of any rate cut. Given Powell’s comments combined with the possibility of a slowing economy the market is now forecasting an approximately 60% chance of three .25% rate cuts or more. Three cuts of .25% would move the fed funds interest rate from the current range of 2.25 to 2.5% down to 1.5% to 1.75%. Expectations of lower interest rates has had a signification effect on current bond yields. The two-year Treasury is currently yielding 1.75% and the ten-year Year Treasury is yielding 2.01%. Lower interest rates have driven strong returns in the Barclays US Aggregate Bond Index. The index was up 3.08% for the second quarter and was up 6.37% for the first half of the year. We think the Fed will have one .25% rate cut in 2019, but we don’t expect more cuts unless the economy slows dramatically.

Analyst earnings projections for 2019 have dropped from $155 from the end of the first quarter to $151 for a forward price to earnings (P/E) ratio of 19.61. Over the last ten years the P/E ratio has averaged 19.7. Using the P/E of 19.7 multiplied by earnings of $151 for the S&P 500 Index provides a target of 2975. This is near the current level of the S&P 500. We must consider the possibility of an unforeseen event and the negative consequences for the S&P 500. A small adjustment to the P/E ratio down to 17 times earnings would lower the index to 2567 or approximately 15% lower than the current level. The last five years the P/E ratio has averaged 22.46. Using the P/E of 22.46 multiplied by earnings of $151 for the S&P 500 provides a target of 3391. This would be an increase of 15% from current level. Given the low interest rates and comments from Powell, we think it is more likely to see some P/E expansion from the current level. Given the current risk of a 15% drop compared to the reward of 15% we recommend that investors maintain their stock exposure at the neutral point of their target range with more exposure to value stocks.

Investing involves risk, including the possible loss of principal and fluctuation of value.  Past performance is no guarantee of future results.

This letter is not intended to be relied upon as forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.  The opinions expressed are as of the date noted and may change as subsequent conditions vary.  The information and opinions contained in this letter are derived from proprietary and nonproprietary sources deemed by Virtue Asset Management to be reliable.  The letter may contain “forward-looking” information that is not purely historical in nature.  Such information may include, among other things, projection and forecasts.  There is no guarantee that any forecast made will materialize.  All information is illustrated gross of investment advisory fees. Reliance upon the information in this letter is at the sole discretion of the reader.  Please consult with a Virtue Asset Management financial advisor to ensure that any contemplated transaction in any securities or investment strategy mentioned in this letter align with your overall investment goals, objectives and tolerance for risk.  Additional information about Virtue Asset Management is available in its current disclosure documents, Form ADV and Form ADV Part 2A Brochure, which are accessible online via the SEC’s investment Adviser Public Disclosure (IAPD) database at www.adviserinfo.sec.gov, using CRD#283438.

Virtue Asset Management is neither an attorney nor an accountant, and no portion of this content should be interpreted as legal, accounting or tax advice.