All in all, the economy appears to be in a good place. After a slight pause for breath in early April, equity markets continued their upward climb through the end of May. June was less kind however, with European markets giving up most of the quarter’s gains (though still up year-to-date). The U.S., Japanese, and emerging equity markets managed to hold on to most of their gains for the quarter. Having fallen since March, government bond yields saw a sharp spike upwards at the end of June as investors responded to a less dovish tone from central bankers and to the fact that the European Central Bank (ECB) could soon begin reducing its quantitative easing (QE) purchases.

One of the key questions for the rest of the year will be the extent to which bond and equity markets can withstand a gradual reduction in monetary stimulus, which has helped to support markets in recent years.

Over the past 18 months, the U.S. Federal Reserve has proceeded to normalize monetary policy, hiking rates four times to 100 basis points on the Fed funds rate, with most expecting one more hike by the end of the year. One of the most impressive and noteworthy observations of the current cycle is that despite this tightening of a full percent, global U.S. dollar financial conditions remain at near-record levels of ease, due to the global release of over $10 trillion of central bank liquidity. This liquidity has supported both stocks and bonds and has ensured that credit availability has not been constrained, helping to extend the economic cycle.

We believe this recovery can continue and last even longer than most people think, mainly because the last recession was so severe that it is taking longer for economic excesses to build up. So far, we are not seeing any of those excesses or signs of trouble on the horizon. We would note that bear markets are nearly always caused by recessions, and our view is that the probability of a recession over the next 12 months remains low. In addition, the labor market remains very healthy and consumer confidence is high. The Conference Board’s leading indicator is strong, as are both ISM business surveys. More good news is that corporate credit remains sound with spreads contracting, and there continues to be a synchronized global recovery, as well as domestic economic rebound. Finally, corporate earnings growth has resumed after two years at a stand-still and could accelerate further with the possibility of corporate tax cuts.

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