As of April 16, 2019
- A change in policy direction by the Federal Reserve fueled investors’ appetite for risk in the first quarter 2019.
- However, an “inverted yield curve” in late March raised recession concerns.
- Technology, industrials, REITs and energy stocks outperformed the broader equity market.
- If economic data improves, stocks and other risk assets could be well positioned for good performance.
- Earnings results are always critical, but the upcoming earnings season carries significant weight.
- Most investors expect the U.S. and China to strike terms on a trade deal in the coming months.
Data Source: FactSet
Markets are quick out of the gate despite uncertainty
With the second quarter now underway, markets stand at a crossroads. We’ve seen unusual occurrences in the fixed income markets — most notably a rare, inverted yield curve — as short-term Treasury securities generated a higher yield than did longer-term Treasuries. A trend of slowing global economic growth continued. There is concern that first quarter profit trends among U.S. companies may look as ugly as the previous warnings from analysts and companies. These are all issues to watch, but not to the point of justifying a change in direction on asset allocation and portfolio decisions.
The market’s own performance in the first quarter was impressive. The S&P 500 Index is coming off its best start to a year since 1998, and risk assets across the globe have demonstrated notable resilience in the face of slowing economic growth and continued trade uncertainty.
The Fed shifts course
Importantly, the Federal Reserve may be on the sidelines for the rest of the year when it comes to raising interest rates. Other global central banks are also responding to slower growth trends this year by signaling a preference toward monetary easing (lowering rates or taking other steps to add liquidity to their economies). Generally, stocks and high yield fixed income securities perform well in environments where central bankers are either easing monetary policy or holding steady. In our view, this could add a tailwind to some portfolios if global economic data can stabilize over the coming months.
Some consider an inversion in the yield curve to be a possible signal that a recession is imminent. Yet historically low levels in U.S. unemployment are helping boost the financial well-being of American households, increasing the number of productive citizens, and giving more consumers the opportunity to spend and contribute to economic growth. The recent decline in interest rates could boost home-buying activity over the coming months as well. We believe lower interest rates, combined with a strong labor market, could bode well for the housing sector and the broader economy this year.
The consumer is responsible for roughly 70 percent of economic activity in the U.S. A strong labor market and a healthy consumer could keep corporate profits growing this year. Still, we anticipate that the rate of growth will slow compared to last year. If businesses can avoid reacting too negatively to data that indicate a slower-growing economy and to increasing wage pressures, we believe the strong labor market may hold over the coming quarters. That would be another positive factor for the markets.
Key factors to watch
For markets to continue their trek higher through the second quarter, we believe these three macro-economic factors would need to trend in a positive direction:
- Global economic data will need to stabilize and improve. As second quarter manufacturing and home data become available, investors will want to see improvement. Lower interest rates, a Federal Reserve on pause and a robust labor market are all factors that could help accelerate economic growth in the second quarter.
- S. corporate profit and sales growth will need to hold or surpass expectations. The low hurdle rate for first quarter earnings results affords U.S. companies an excellent opportunity to exceed expectations as they report earnings in the coming months. We believe such an outcome would be greeted favorably by investors. On the other hand, if companies barely meet or miss analyst profit forecasts and at the same time reduce expectations for sales results in the second quarter, stocks may face a more challenging environment.
- The U.S. and China will need to ink some form of a trade deal in the months ahead. Simply put, for investors to feel comfortable with riskier assets, we believe they will need to feel relatively confident that the U.S. and China are unlikely to derail economic and profit growth by raising barriers on trade.
See where you stand
The second quarter could be a very telling inflection point for markets and the economy this year. We believe risk assets have room to rise if the data on the strength of the economy and corporate profits are supportive. If evidence continues to mount against an acceleration of growth from here, then investors should expect more volatility across their portfolios over the coming months. Talk with your financial advisor to make sure you are comfortable with how your portfolio is currently positioned.
Data source: Morningstar Direct
As of April 8, 2019