2019 began with enthusiasm in the face of mixed signals. Despite concerns over unresolved U.S.-China trade relations, shaky Brexit plans, and near-term corporate earnings and bond doubts, the first quarter saw a 13% gain in the S&P 500 and improved employment and wage numbers. Central banks moderated monetary policies in anticipation of a less robust economy that hasn’t yet materialized, and the real estate market began to show signs of heating up again.
The current bull run of the market is extending into a record tenth straight year. However, unresolved global issues and uncertainties around Fed behavior are caution flags for the prudent investor.
ECONOMIC CONDITIONS UNITED STATES:
GDP: At the end of the first quarter, the Bureau of Economic Analysis downgraded Q4 2018 gross domestic product (GDP) to 2.2% from the initial estimate of 2.6%. The Institute for Supply Management’s monthly purchasing manager index (PMI) that follows manufacturing activity dipped from last summer’s levels near 60 but held averages in the mid-50’s throughout Q1.
UNEMPLOYMENT: Job creation surged, then saw a massive drop off: January reported 311,000 net new jobs while February only reached 20,000. The unemployment rate dropped from 4.0% in January to 3.8% in February, and the broader U-6 rate encompassing the underemployed went from 8.1% down to 7.3%. (The federal government shutdown may have affected some of the above numbers.) 
HOUSING: February’s existing home sales swelled to 11.8% according to the National Association of Realtors (NAR), the largest monthly gain since December
2015. While residential resales were still down 1.8% year over year, this latest NAR report is encouraging. NAR chief economist Lawrence Yun cited “lower mortgage rates, more inventory, rising income, and higher consumer confidence” as contributing factors. Additionally, the Census Bureau says the pace of new home buying improved 4.9% during February despite the 1.3% forecast from economists surveyed by Reuters.
INTERNATIONAL: Financial markets worldwide breathed a collective sigh of relief as the trade dispute between the U.S. and China eased. Negotiations between the two nations continued during the quarter, but no deal emerged. While some trade analysts see an agreement being reached in the second quarter, there are doubts that such an accord will resolve the issue at the center of the tariff fight: the concern that Chinese firms are using their technologies to steal U.S. intellectual property. In March, President Trump said that he would prefer leaving 25% tariffs on $50 billion of Chinese products in place, even if a new trade deal was forged. 
In the U.K., the quarter ended with Parliament rejecting Prime Minister Theresa May’s latest revised Brexit deal for a third time. The Brexit deadline is now extended from April 12 to October 31, agreed upon by both the U.K. and the EU.
The European Central Bank surprised financial markets in early March with a decision to revive some of the economic stimulus measures it had recently ended and indicated it would leave interest rates unchanged until at least 2020. The latest forecast from the Organization for Economic Cooperation and Development (OECD) projects only 1% growth for the eurozone in 2019 and less than that for the economies of Germany, Japan, and the United Kingdom.
US EQUITIES: As the table above shows, the major U.S. equity benchmarks recorded great gains in Q1, extending the aging bull market. Here are the closing settlements on the last trading day of Q1:
-Dow Jones Industrial Average: 25,928.68. -S&P 500: 2,834.40. -Nasdaq Composite: 7,729.32. -The S&P Smallcap 600 ended the quarter at 939.30.
DEVELOPED INTERNATIONAL EQUITIES: Our S&P 500 was just one of many equity benchmarks advancing double digits in the first quarter. In fact, nearly every foreign stock index posted a quarterly gain of some kind and all outperformed the S&P for Q1; Italy’s FTSE MIB: 16.17%; France’s CAC 40: 13.10%. Other notable gains: Canada’s TSX Composite: 12.42%; Euro Stoxx 50: 11.66%; Germany’s DAX: 9.16%; the United Kingdom’s FTSE 100: 8.19%; Japan’s Nikkei 225: 7.56%; MCSI’s World index rose 11.88% in the quarter.
EMERGING MARKETS: MSCI’s Emerging Markets rebounded 10.41% after falling 6.14% during the previous quarter. Individual EM countries posted impressive gains as well. Hong Kong’s Hang Seng: 14.41%; China’s Shanghai Composite surged 26.77%; India’s BSE Sensex: 8.11%; South Korea’s KOSPI: 6.19%.
U.S. FIXED INCOME: Demand for longer-term Treasury notes rose. By March 22, the yield on the 10-year Treasury had fallen dramatically, to the point where the yield on the 2-year Treasury exceeded it. (Bond yields fall when bond prices rise.) Economists refer to this as an inverted yield curve.
Developed International Fixed Income: After the Fed’s meeting in mid-January, many central banks followed suit, setting up expectations of lower rates going forward. The Global Aggregate Bond Index gained 3.12% on the dovish sentiment along with continued uncertainty surrounding the Brexit.
BIG FED REVERSAL ON GROWTH FORECAST AND INTEREST RATES
Just late last year, the Federal Reserve was forecasting two interest rate hikes for 2019 and maintained a hawkish outlook. We saw a pause from the Fed in December, due to mounting equity losses along with increasing pressure from the White House. Then in the first quarter, we witnessed a full capitulation from the central bank on both rates and its bond run-off. It cut its 2019 growth forecast for the economy by 0.2% to 2.1%, indicating it would not raise interest rates this year, and projected just one quarter-point hike through 2021. At a press conference immediately after the release of the policy statement, Fed Chairman Jerome Powell shared his view that the “growth of economic activity has slowed,” but he added that Fed policymakers did not foresee a recession developing.4 The futures market flipped as well, and are now pricing in a rate CUT in 2019 as seen in the chart below. The equity markets reacted swiftly to the Fed pivot, in the hopes that the current bull still has some room to run.
PROVIDING STABILITY AMONG UNCERTAINTY
As we began the year, we sought to take advantage of a volatile end of 2018 by adjusting allocations and reinvesting in favorably valued equities. Within our fixed income allocations, we have extended our duration modestly as the change in monetary policy should anchor longer-term yields. In our alternatives investments, we have moved to buffer against an equity downturn while still benefitting from any upside surprises that may result from trade news or an uptick in earnings forecasts. Finally, as the quarter ended, we took advantage of market gains, again adjusting portfolios to harvest profits, yet getting more defensive in our equity posture.
Despite the strong 1st quarter results and return to relative market calm, a great deal of uncertainty remains. While the Fed capitulation has reduced volatility and provided a floor for markets, and the risk of recession remains low over the next 12 months, we remain cautious. The current bull is aging and the outlook for growth and earnings is slowing. As always, we remain vigilant and proactive in working to protect portfolios against the inevitable downturns.
1 – investing.com/economic-calendar/ [3/31/19]
2 – pbs.org/newshour/economy/new-round-of-u-s-china-trade-talks-set-to-begin-in-beijing [3/28/19]
3 – cnbc.com/2019/03/29/ brexit-general-election-speculation-grows-after-may-loses-vote.html [3/29/19]
4 – cbsnews.com/news/fed-rate-hikes-none-in-2019-federal-reserve-projects-no-rate-hikes-slower-growth-this-year/ [3/20/19]
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