The U.S. economy is growing at an above-trend pace, and the rest of the world seems to be finding its footing. Meanwhile, the Federal Reserve (Fed) continues to normalize monetary policy, and it appears that other central banks are following suit. Interest rates have come down off the highs seen earlier this year, and equity valuations are no longer looking as pricey. With this as the setup, how should investors think about navigating markets during the second half of the year?
With respect to growth, the second half of this year should be better than the first. The weakening in global goods demand that led to disappointing growth metrics in the first quarter seems to have worked its way through the system, with U.S. consumption expected to have grown by nearly 4% from a year prior in the second quarter, and retail sales in Europe showing signs of stabilization. Furthermore, the Purchasing Managers Indices (PMIs) and other soft data all point to a continued improvement in growth outside of the U.S. While the hard data will need to provide confirmation of this trend, the clouds which have been hanging over the international economy for the past few months finally seem to be breaking.
Solid growth in and outside the U.S. would align with policymaker expectations, leading the Fed to continue hiking rates and the European Central Bank (ECB) to hike for the first time around the middle of next year. If these expectations are realized against a backdrop of solid economic growth, it could lead the dollar to soften, providing a boost to emerging markets and supporting a resynchronization of growth as we approach 2019. This resynchronization of global growth could help alleviate trade-related concerns, and provide support for risk assets to move higher. With earnings growth looking solid, equity valuations in-line with or below their long-term averages around the world, and interest rates still historically low, stocks should be able to rally into 2019. However, diversification should remain the central tenet of any investment strategy given the political risk premium which continues to exist in markets around the world.