The stock market made an impressive comeback in the first quarter of 2019, ending the fourth quarter of 2018 on a sour note with many participants looking to “leave the game early.”
Equities, bonds and commodities made their lows on Dec. 24, Christmas Eve, a holiday-shortened, but no less brutal, day for the financial markets. A day that saw the S&P 500 lose 2.7% in just three hours of trading, closing just shy of 20%, 19.8% to be exact, off its most recent high. Crude oil declined as well, losing 44% in a mere three months, to close at $42.50 per barrel. Investor sentiment was understandably both dour and at near-panic as folks opened their presents on Christmas Day.
That is when the fun began — for those investors who kept faith and remained in their seats to watch another inning of the game play out — as the S&P 500 proceeded to notch its highest quarterly gain since 2009 and best first quarter in 20 years. The first quarter of 2019 saw a global rally across nearly every asset class, including equities and fixed income, which was as broad in scope as the losses were in the fourth quarter of 2018. The S&P 500 saw gains of 13.6% in the quarter, while global developed stocks rose 12.3%; Emerging Market stocks rose 9.9%. All sectors in the S&P 500 showed strong gains, ranging from a 7.0% gain for the weakest sector, Health Care, to the 19.8% gains for the strongest performing sector, Technology.
2019 First Quarter and One-Year Trailing Returns Across Asset Classes
Where Are We Now? A Look at Six Factors
1. The Fed
The Fed is clearly on hold for rate increases in 2019, after their dramatic pivot during the quarter. Fed policy is on the market’s side this year. Economic factors will need to drastically change for the Fed to move rates in either direction this year.
2. The Economy
The U.S. economy is still in very good shape. The Fed sees GDP growth of 2.1% this year, moderating from 2018 but still solidly positive.
3. Consumer Strength
Comprising nearly 70% of GDP, consumers continue to enjoy tailwinds as the unemployment rate remains at generational lows. More workers are reentering the job market helping to support the market’s current positive view of consumer spending and sentiment.
4. Wage Growth
Worker wages are increasing at a very healthy 3% rate, which leads to increases in consumers’ disposable income. Given the tight labor market, the return of workers to the labor force helps provide some relief to this headwind for corporate profits.
The inflation rate remains low and manageable at 1.9%, in line with the Fed’s 2% inflation target. The Fed sees the inflation rate remaining at this level in both 2019 and 2020, further supporting their pivot toward a more accommodative monetary policy.
6. Trade War
Through the first quarter, trade talks involving the U.S. and China continued with positive comments trickling out from every meeting between the two. It is in both countries’ best interest to sign a deal and declare victory; China’s economy has slowed markedly due to the tariffs enacted thus far, and the White House does not want to enter an important election year with a domestic economy slowed by tariffs. A completed deal could be announced as soon as mid-year, though many details remain to be resolved.
Second Quarter 2019 Outlook
At any point in an economic cycle, there can be different opinions as to “how much game is left” in terms of where the economy and financial market cycles stand. This remained true as the first quarter came to a close.
There are two competing outlooks of the future for the coming year:
1. Glass Half-Full
Although earnings growth will be slower this year, GDP growth of 2.1% is still a very solid rate of growth after nine years of economic recovery. Unemployment is low, consumer and business confidence are high and lower tax rates should continue to boost consumer spending. Wages are growing at a manageable level for businesses to absorb without pressuring their margins, while providing a further tailwind for the consumer. Corporate and high yield bond spreads have tightened from the prior quarter, potentially indicating that investor worries about corporate health have returned to being fairly benign. Inflation is low and under the watchful eye of the Fed, who continues to support asset prices.
Mortgage rates have fallen from their recent highs, spurring a rebound in housing activity. Capital spending is expected to be strong this year with higher corporate profits and more cash repatriation from overseas. Although we are in the 10th year of economic recovery, aggregate GDP growth over this decade has been below prior cycles, creating the potential for a longer than usual cycle.
2. Glass Half-Empty
In late March, the yield curve inverted, as the yield on the 3-month government T-bill moved up to 2.46%, eclipsing the yield on the 10-year government bond at 2.36%. This “yield curve inversion” indicates that financial market investors may be worried about an impending economic slowdown resulting in a recession. An inverted yield curve has been a very dependable historical barometer of a coming recession and bears watching.
Student loan debt has ballooned and housing costs are high, especially in large cities. While mortgage rates have declined, they remain higher than they were over the last few years. These factors affect younger generations’ plans to buy a house, spend on discretionary items and plan for their financial future. A slowdown in global economic growth, particularly in Europe, may be imported into the U.S., which would, in turn, lead to a severe domestic economic slowdown. The economy is in the 10th year of a recovery, long by historic standards, so could be due for a slowdown and potentially a recession. Equity valuations are high and may not be appropriately priced for an impending potential economic slowdown. Any benefit from a completed trade deal between the U.S. and China could be already priced into the stock market, given the sharp rebound in the first quarter.
Whether an investor sees the current economic environment as a glass half-full or half-empty, these differences of opinions are what makes a market. The S&P 500 lost 13.5% in the fourth quarter of 2018 and gained 13.6% in the first quarter of 2019. Those were a long six months to end up in relatively the same place. If long-term investors had not seen any financial news in the last six months, they probably could have saved themselves a lot of short-term angst, worry and gray hairs.
Baseball seasons are long — 162 games to be precise. Every game is important, but so is perspective on the future.