Optimism returned during the first quarter of 2019, following a difficult fourth quarter during which the S&P 500 Index dropped 13.5%. Boosted by a suddenly dovish Fed and a White House that now seems reluctant to further increase tariffs on China, the S&P 500 posted its best quarterly gain since the third quarter of 2009 and its best first quarter since 1998. The S&P 500 index rose 13.7% during the first quarter, the Dow Jones Industrial Average was up 11.8%, and the Nasdaq jumped 16.9%. The first quarter of 2019 saw a shift in sentiment in non-U.S. markets as investors became optimistic that economic growth will stabilize and earnings growth will turn modestly positive. Key drivers of this shift in sentiment have been a seemingly less hawkish Federal Reserve, a decrease in trade tensions, and early signs of stabilization in China.
Fixed income markets generally produced positive results during the quarter as a more cautious Fed ended three years of monetary policy tightening. Coming into the quarter, markets expected the Fed to continue raising rates well into 2019 and, perhaps, into 2020. Rising rates combined with the continued balance sheet runoff and hawkish comments from many other central banks set the expectation that yields would be moving higher and credit spreads would be widening. However, following its March Federal Open Market Committee (FOMC) meeting, the Fed left policy rates unchanged and also articulated a surprisingly detailed plan for concluding the balance sheet runoff. Falling interest rates positively drove returns as the 10-year Treasury bond yield dropped from 2.7% to 2.4% during the first quarter.
In the U.S., equity markets resumed their uptrend following a short pause late in 2018. The economy, however, continues to slow, the yield curve inverted (the three month vs. the ten year inverted for four days), and year-over-year corporate earnings growth will likely be negative when first quarter results are reported. The year-to-date rally has pushed equity market valuations significantly higher. Margins are under pressure as a result of a stronger dollar and rising wages and input costs. Analyst revisions have moved into negative territory. For Q1 2019, 79 S&P 500 companies issued negative earnings per share guidance and 28 S&P 500 companies issued positive earnings per share guidance. Given these dynamics, it would be reasonable to conclude that a market pullback is becoming increasingly likely. Recent policy responses, including increased economic stimulus in China, improving U.S.-China trade talks, and a more dovish Fed, do have the potential to extend market gains and postpone such a pullback.
In developed overseas markets, European equities remain challenged by weak economic momentum and political risks. Significant corporate earnings growth may prove difficult in this environment. Japanese equities are supported by attractive valuations, shareholder-friendly corporate behavior, central bank stock buying, and political stability. Uncertain earnings growth, however, is a key risk. Finally, a solid macro backdrop, near term resilience in China, and solid corporate earnings serve as tailwinds for Asia ex-Japan equity issues. A disruption in global trade or a greater-than-expected slowdown in China are significant risks to the region.
Emerging market valuations remain attractive, even after the year-to-date rally, and fears about broad contagion from mid-2018 have fallen. Accommodative policy measures in China and a dovish shift by the Federal Reserve are tailwinds. Risks to the asset class do exist. For example, if the Chinese economy fails to avoid a significant slowdown despite stimulus efforts by the government or if the U.S.-China trade dispute escalates or drags on, emerging market stocks are likely to suffer.
A slowing, but still growing, global economy should be supportive of fixed income markets. Global inflation pressures remain subdued, and are unlikely to drive short term changes in world monetary policy. The current less-aggressive stance from the Fed has eased pressure on fixed income assets from rising short term rates. Coupon income, rather than capital appreciation, should be the dominant driver of bond returns in the quarters ahead. Given late cycle dynamics and the expectation of volatility, we anticipate the historically negative correlation between U.S. equity and government bond returns to hold in the near term. In other words, expect Treasuries to act as a buffer when risk assets sell off.
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Based on the S&P 500 trailing twelve-month Price-to-Earnings ratio, a gauge of U.S. equity valuation registers a current reading in the 23rd percentile.
Based on the Federal Reserve Bank of Philadelphia’s U.S. Coincident Index, a gauge of U.S. economic activity registers a January 2019 reading in the 29th percentile.
This economic and market commentary was prepared by Capital Market Consultants, Inc. (CMC), an independent investment management consulting firm, and has been approved for distribution by GW & Wade, LLC. Data used to prepare this report by CMC are derived from a variety of sources believed to be reliable including well established information and data software providers and governmental sources. CMC is not affiliated with any of these sources.
The information provided above is general in nature and is not intended to represent specific investment or professional advice. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship.
About the indices presented above:
- Standard & Poor's 500 (S&P 500®) Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.
- The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq.
- The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
- The MSCI ACWI (All Country World Index) is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world.
- The MSCI EAFE Index is an equity index which captures large and mid cap representation across Developed Markets countries around the world, excluding the US and Canada.
- The MSCI Emerging Markets Index (EM) captures large and mid cap representation across 24 Emerging Markets (EM) countries.
- The Bloomberg Barclays Global Aggregate Bond Index measures global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
- The Bloomberg Barclays US Aggregate Bond Index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States – including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year.
- The Bloomberg Barclays US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.
- The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. GW & Wade assumes no duty to update any of the information presented above.
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