As of February 19, 2019
- U.S. stocks posted their best January in 30 years.
- The longest ever U.S. government shutdown ended with many contentious matters unresolved.
- Trade discussions advanced between the United States and China, but thorny structural issues remain.
- S&P 500 profits are expected to grow by just 5 percent in 2019 — down significantly from previous projections.
- Washington gridlock and trade uncertainty continue to pose risks for investors.
- The IMF* forecasts global economic growth could slow in 2019, due principally to negative effects from tariffs.
Data Source: FactSet
* International Monetary Fund
Conditions return to normal
Although trade tensions remain a concern and pose a risk for stock prices as of this writing, investors seem to be taking a more sanguine view of market conditions at the start of the year.
Since reaching their low points during the market downturn in December 2018, prices of global stocks have since soared, recovering a meaningful portion of their fourth quarter losses. The longest-ever U.S. government shutdown, which ended at the end of January, temporarily weighed on investor sentiment and may have dented first quarter economic growth. Even still, investors licked their wounds and appear to be a bit more bullish today.
According to the American Association of Individual Investors (AAII), bullish sentiment bounced back from a five-year low in December to more normal levels in recent weeks. Similarly, the extreme bearishness that dominated investors’ outlook at the end of last year has also subsided. The survey’s bearish reading has stabilized. Rising equity markets have unsurprisingly led to stronger investor sentiment and created a positive feedback loop for asset prices.
Interestingly, a greater number of respondents to the AAII survey now report they have neutral expectations for the market. The strong gains realized since December’s lows may have more investors cautious on buying stocks and considering recent volatility.
Factors triggering the market’s recovery
In our opinion, asset prices are on the mend thanks to five key factors:
- The Fed’s change of direction. The Federal Reserve pivoted away from tighter monetary policy last month. Going forward, it has indicated it will be more sensitive to global market risks and will require stronger evidence of an overheated economy before raising rates again. In our opinion, the risk of the Fed making a policy “mistake” of raising rates too quickly has substantially declined.
- Low earnings expectations. Analysts now anticipate that earnings growth will slow materially through the first three quarters of 2019. Ironically, low expectations could create more opportunity for companies to outperform profit estimates. Some investors have already jumped at the chance to potentially capitalize on future favorable earnings surprises, especially given how beaten up stock prices were at the end of December.
- A resilient U.S. economy. Economic data is surprisingly favorable, the job market is the strongest in decades and consumers appear to be in very good shape.
- Progress on trade disputes. Both China and the U.S. seem eager to strike a deal that avoids an escalation in tariffs after the March 1 trade ceasefire expires. Investors may be anticipating a potential deal. At a minimum, a deal could provide a temporary reprieve that avoids escalating tariff rates on Chinese imports, which would further roil global markets.
- The December downturn went too far. As data has supported a more positive economic outlook and the Fed has taken a pause in rate hikes, attractive valuations allowed investors to take advantage of short-term price dislocations.
The path ahead remains uncertain
In our view, stocks and bonds are fairly valued in the current environment. January’s rebound was a clear indication that the market turned too pessimistic at the end of last year. Nevertheless, stocks and other types of “risk” assets will need positive catalysts to push higher from here.
Positive moves in the market may rely in large part on favorable trends in trade negotiations, corporate earnings results and economic data. Any negative developments on each of these fronts could pose downside risks for investors.
Washington gridlock, falling U.S. profit forecasts, decelerating global growth, Brexit uncertainty and trade friction currently fog the investment landscape. As the year develops, we anticipate the haze could clear on several of these issues. For now, investors can take comfort in a market on the mend while maintaining a well-diversified portfolio. Despite the fresh start in 2019, a cautious approach is still warranted. Talk to your advisor to make sure your portfolio is properly positioned for an uncertain environment ahead.
Data source: Morningstar Direct
As of Feb. 13, 2019