Financial markets stabilized in the first quarter of 2019 following a turbulent end to 2018. Markets seemed relieved in the Fed’s pivot to a more dovish stance. More recent economic releases point to a moderation in growth as compared to the pace that was experienced in the second and third quarters of 2018. The big question on the minds of investors seems to be whether the economy will simply slow back to the rate of growth that has characterized the recovery-to-date (i.e. a “soft landing”) or will slip into a recession sometime in the coming months.
Looking at the big picture, fourth quarter GDP growth clocked in at +2.2%, which was a downward revision to the 2.6% initial estimate released in February. As noted above, this was a deceleration from the pace witnessed in the second and third quarters of 4.2% and 3.4%, respectively. For the full calendar year 2018 the economy expanded at 2.9%, just shy of the 3% rate of growth that has been elusive for any full calendar year going back to 2005.
As the first quarter of 2019 concludes, it appears that the economy has taken another step downward in terms of overall growth. The government shutdown that began in December and lasted through most of the month of January took a toll on both business and consumer sentiment. According to FactSet, GDP for the first quarter is expected to come in around 1.7%, while calendar year growth currently looks to be 2.4%. Assuming the US avoids recession in the next two quarters, the current expansion will surpass the length of that experienced in the 1990’s and become the longest on record.
The employment picture has remained robust so far in 2019. The February employment report contained a mixed bag of data points on the current strength of the economy. On the plus side, the headline unemployment rate ticked back down to 3.8% from 4.0% in January. Average hourly earnings growth remains strong with an increase of 3.5% over the past twelve months. The polar vortex along with the remnants of the government shutdown earlier in the year took a toll on payroll growth with a much weaker than anticipated gain of only 20,000 new jobs vs. an expectation of 180,000. However, jobs growth for the prior two months was revised upward by 12,000 and the three-month rolling average remains a respectable 186,000. The labor market has now added jobs for 101 consecutive months, the longest streak ever.
A major factor pointing toward continued strength in the job market in the coming months is the fact that unfilled job openings remain near a record level as employers continue to search for qualified employees to fill the available positions. According to the Labor Department there were over 7.58 million unfilled jobs in January and only 6.24 million individuals who are currently unemployed and actively seeking work. This gap has persisted for the past 11 months and appears likely to continue as there are over one million more jobs available than there are workers to fill them.
Domestically, the manufacturing side of the economy remains in expansionary territory. The February ISM index came in at 54.2. Although this was a decline of 2.4 points from the January number and below the consensus estimate, anything above 50 denotes expansion. Survey participants noted that the domestic economy remains robust, although weather did have an impact on activity in the first two months of the year. Uncertainty over tariffs and the ongoing trade dispute with China were noted as negatives.
Consumers remain upbeat overall, however the most recent consumer confidence index released in late-March declined following a rebound in February. While overall consumer confidence remains just shy of the record levels last seen in the late-1990s/early-2000s, the overall trend in confidence has been softening since last summer. In recent months, financial market volatility, the government shutdown and a weaker than expected February jobs report has had an impact on consumers.
Globally there remain several factors that continue to cloud the outlook for economic growth. Lawmakers in Britain rejected Prime Minister Theresa May’s Brexit deal for a third time, despite her offer to quit as PM if her agreement was passed. This development further increases the chances that the U.K. will either delay its departure from the European Union or leave the bloc on April 12th without any agreement to ease the disruption. Elsewhere in Europe, Germany’s key manufacturing index pointed to a further contraction in that nation’s industrial activity. Finally, trade negotiations between the U.S. and China resumed, leading to hopes that a resolution will soon be reached between the two countries.
Bond yields declined to fresh lows in the concluding days of the first quarter following a dovish Fed outlook and economic data that continues to point to slowing growth both globally and here at home. The yield on the 10-year US Treasury note dropped below 2.40%, matching the levels last seen in late- 2017 and well below the multi-year highs of 3.25% seen last November.
Globally, yields have also traded down to multi-year lows with the German 10-year bond yield trading in negative territory for the first time since 2016. Government bonds in Switzerland, Japan, and Denmark all carry negative yields. Short-term rates in the U.S. have also retreated as the Federal Reserve’s Open Market Committee signaled that they are likely to remain on hold in the upcoming months. In the statement released at the conclusion of their March meeting, Fed officials reduced the number of interest rate increases they expect in 2019 from two to zero and only one in 2020. Following that meeting the yield on the 2-year Treasury note dropped to 2.31%, a level last seen in the first half of 2018. Fed funds futures markets are now pricing in a 70% probability of a rate cut by year-end, up from a 5% chance at the beginning of February.Another closely watched indicator in the bond market, the slope of the yield curve, also flashed a warning signal in the final days of the quarter as the yield on the 10-year Treasury fell below that of the 3-month. The unusual condition where short-term rates are higher than long-term rates has been one of the more consistent indicators of a looming economic slowdown. While an inverted yield curve has preceded every recession over the past several decades it is also important to remember that not every inversion has been followed by a recession. Rather than being the cause of a recession, an inverted yield curve is a signal that the markets believe the Federal Reserve may have tightened monetary policy beyond the level that is warranted by current conditions.
Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).
|Treasury Bill||Treasury Notes & Bonds|
|3 mo.||2 yr.||5 yr.||10 yr.||30 yr.|
The total return numbers for various fixed income indices over the last twelve months are displayed below (data from Bloomberg).
|12 Month Returns (as of 3/29/19)|
|Barclays Capital US Aggregate||4.48%||Merrill Lunch US High-Yield||5.92%|
|Barclays Intermediate Government||3.79%||Merrill Lynch US Municipal Index||5.21%|
|Dow Jones Corporate||5.54%||JP Morgan EMBI Global||3.52%|
The first quarter of 2019 ushered in a sizable change in stock market momentum following the fourth quarter sell-off that saw the Dow, S&P, and Nasdaq all decline by double-digits. January’s 8% return was the best start to a calendar year since 1987 and was followed-up with continued gains in the month of February that put the S&P up 11.5%, the highest return for the first two months of a calendar year since 1991. Returns moderated a bit in the month of March, but still managed to tack on additional gains with the S&P finishing the month up by just under 2%. For the entire three-month period, the total return for the S&P 500 was 13.65%, which was the best first quarter return since 1998. This marks only the 11th time since 1950 that the broad index has gained more than 10% to begin the year. According to the Wall Street Journal, the index has risen the remainder of the year in nine out of the 10 previous occasions, with the one exception being 1987, the year of the stock market crash known as Black Monday.
With the rally in the stock market so far this year, the S&P has risen over 20% from the intra-day lows reached in late-December and is back within 5% of the all-time highs that were set in the late-summer/early-fall. A major milestone was reached during the first quarter when the bull market that began in the depths of the financial crisis turned 10 years old. On March 9, 2009, the S&P 500 hit what would become the closing low point of 676.53. Over ensuing decade, the S&P has risen by over 300% and added over $20 trillion in total market value. When dividends are included, the S&P’s total return over the period rises to 400%. Despite the duration of the current bull run, market returns achieved so far still fall short of those experienced during the bull market of the 1990s. Returns during the quarter were well distributed with smallcap, mid-cap, foreign, and emerging market stocks all participating in the rally. Growth stocks were once again in favor over value stocks, as technology was the dominant sector.
Earnings growth is expected to decelerate from the rapid pace seen during 2018 as the initial effects of the tax cut and fiscal stimulus begin to fade. S&P 500 earnings per share grew by double-digits in each quarter during 2018 and rose by over 22% for the full calendar year. For first quarter 2019, earnings are expected to decline by -3.9%, according to FactSet. If that is the case it will be the first year-over-year decline in earnings for the index since the second quarter of 2016. For the remainder of 2019 analysts currently expect earnings to return to positive growth with second, third, and fourth quarter, as well as full year S&P earnings remaining above levels seen in the prior year period. For the full calendar year, earnings are expected to be up in the low single digits. Stock valuations have increased somewhat relative to where they stood at year-end with the forward P/E ratio back above 16x. This puts the market roughly in-line with the average multiple over the past five years and just slightly higher than the average of the past decade. For the remainder of 2019 investor sentiment will likely hinge on how things play out from an earnings growth perspective. Attention will also be on the Fed and how their view of the current state of the economy evolves and the potential monetary policy implications.
|Equity Indices||1st Quarter 2019|
|Dow Jones Industrial||11.81%|
|S&P 500 Growth||14.95%|
|S&P 500 Value||12.19%|
|Russell 2000 (small-cap)||14.57%|
|MSCI/EAFE (developed international)||10.15%|
|MSCI/EM (emerging markets)||9.90%|
Technology was the best performing sector in the first quarter as some of the large tech stocks such as Facebook, Netflix, and Apple rallied by 20%-30%+ following steep sell-offs at the end of 2018. Energy was also one of the top performing sectors as the price of crude oil rebounded to $60 per barrel after closing out 2018 trading in the mid-$40s. Financial stocks, while still positive for the quarter, were one of the bottom performing sectors as investors grow increasingly concerned about the impact of the flat yield curve on bank net interest margins.
The following table details S&P 500 sector total returns for the quarter.
|Return by Stock Sector||1st Quarter 2019|
|1. Information Technology||19.86%|
|2. Real Estate||17.55%|
|5. Consumer Discretionary||15.73%|
|6. Communication Services||13.98%|
|7. Consumer Staples||12.01%|
|11. Health Care||6.60%|