After suffering through the painful market decline of the fourth quarter of 2018, investors saw market indices bounce back in the first quarter of 2019. Investor confidence rebounded sharply as the S&P 500 posted a 13.6% gain and all the major asset classes rose. We aren’t quite back to September’s highs, but the S&P 500 has recovered over 80% of last year’s decline.
March 9th marked the tenth anniversary since the stock market lows were reached back in 2009. Over that time we’ve seen over 300% gains in US stocks. A big part of those returns has come as a result of the Fed’s stimulative policies that have inflated asset prices even as real GDP growth has crept along at fairly low levels.
The US consumer is doing well. Unemployment is down to just 3.8% and the percentage of working-age people who are employed or looking for work is near its highest level since 2010. Strong job figures for March saw 196,000 new jobs created, after just 33,000 were added in February.
As a result, consumers are directing less of their paychecks towards debt payments in recent years than at any other point since Federal Reserve started tracking it in 1980. If the American household was a stock, we would like seeing this kind of strengthening balance sheet.
|Market Index Returns as of March 31, 2019|
|Index||1st Quarter||1 Year||3 Years||5 Years||10 Years|
|S&P 500 (US Large Cap)||13.7%||9.5%||13.5%||10.9%||15.9%|
|Russell Midcap (US Mid Cap)||16.5%||6.5%||11.8%||8.8%||16.9%|
|Russell 2000 (US Small Cap)||14.6%||2.1%||12.9%||7.1%||15.4%|
|MSCI ACWI X-US IMI Net (Foreign Equity)||10.3%||-5.0%||8.0%||2.7%||9.2%|
|MSCI EM (Foreign Emerging)||9.9%||-7.4%||10.7%||3.7%||8.9%|
|Barclays Aggregate Bond||2.9%||4.5%||2.0%||2.7%||3.8%|
|Barclays Muni Bond||2.9%||5.4%||2.7%||3.7%||4.7%|
|Past performance is not an indication of future performance.|
Though the stock market is delivering strong returns, many of the same questions about the economy we had in December have yet to be resolved. At the macro level, trade talks between the US and China are progressing but have yet to result in a new agreement. And though the partial government shutdown came to an end in January after 35 days, the divisive domestic debate over a border wall continues.
In Europe, the UK’s exit from the European Union (known as Brexit) is quickly approaching without a formal plan in place. EU members voted in March to extend the deadline until April 12th if no deal is reached, or May 22nd if the UK Parliament can reach an agreement on a plan. A “no deal” Brexit would likely be the most disruptive scenario for the world’s fifth-largest economy—particularly for people who live and work along the Ireland/Northern Ireland border. At this point, it is hard to predict how Brexit will end up as lawmakers scramble for a deal, and what its ramifications for trade partners will be
Closer to home, one major shift since December is the Federal Reserve’s retreat from monetary tightening. The Fed had raised the Fed Funds rate, which influences interest rates across the financial system, eight times from December 2016 to December 2018, with another two or three additional hikes planned for 2019. At its March meeting, the Fed backed away from planning any increases in 2019 and may possibly consider only one next year. On top of halting rate hikes, Fed Chairman Jerome Powell announced the Fed will also stop shrinking the Fed’s portfolio of Treasury and mortgage bonds accumulated over three “quantitative easing” programs that injected over $4 trillion into financial markets.
Chairman Powell cited slower economic growth as the reasoning behind the shift. US GDP growth is indeed expected to slow in 2019 compared to last year’s 2.9%. A slow growth rate would be in line with recent trends; “slow and steady” has been the best description of the US economy since the financial crisis ten years ago.
Indeed, the current economic cycle (the light blue line on the chart below) has seen the slowest pace of growth compared with all other economic expansions since World War II. Perhaps this chart can explain why the last decade has often been called “the most unloved bull market of all time.” Real growth has never accelerated enough to allow investors to have full confidence in the economy.
Meanwhile, bond markets sent a potentially ominous signal in March when interest rates on longer-term bonds (the 10- year Treasury bond) fell below that of shorter-term bonds (the three-month Treasury bill) for nearly a week. This type of inversion of the yield curve has happened prior to every recession over the past 50 years. The gray areas on the chart on the next page represent US recessions.
Recessions have taken time to begin after inversions in the past—usually beginning six to 24 months after inversion. So do the data say the next recession could be imminent? The Atlanta Federal Reserve is projecting a 2.1% growth rate for GDP in the first quarter, which suffered from the impacts of the extended government shutdown and the cold weather from the polar vortex.
Company earnings growth is in fact slowing down compared to last year. S&P 500 earnings for the first quarter are projected to fall by 3.9% even while revenues are expected to grow by 4.8% according to FactSet. This result for earnings probably reflects the fading impact of last year’s corporate tax cut and profit margins returning to traditional levels. Yet despite the tougher first quarter, corporate earnings are still expected to grow enough to post another year of record earnings in 2019. Needless to say, the Fed’s actions on interest rates have major implications for Main Street and Wall Street and for the first time in a long time, it is really difficult to guess what the Fed will do next. The President is loudly advocating for interest rate cuts and additional quantitative easing. Chairman Powell has left the door open to go in either direction from here.
Though the yield curve inversion sparked worries of an impending recession, one is not quite showing up in the data yet. True, inversions have been a strong indicator in the past but one thing I’ve learned about investing is that the more people believe an investing rule “truism,” the less power it tends to carry in the future. Moreover, yields have been trending this way for several years, so it’s unlikely the Fed changed course as a result. While inversion is a significant event, it’s just part of the equation. So just like the Fed, we’ll have to wait and see.
Matthew S. DeVries, CFA