After a frustrating end to 2018 where we saw December give back all the gains that had been made up until the final month, US Equity markets roared back in the 1st Quarter with the S&P 500 finishing up 13.6%.1 This comes on the heels of the Federal Government Shutdown (a historically long event) and amidst an ongoing Trade War between the US, China, and other major global net-Exporters. S&P 500 Earnings-per-Share growth took a large hit in the 4th Quarter but given the positive numbers we have seen thus far in Q1, that looks to be on the rebound.
- The Federal Reserve announced in March that they were going to hold off on raising rates in March, and potentially for the rest of 2019. That is quite a contrast to where we were this time last year, when the plan was to see 3 rate hikes in 2019 – now, we might see zero.
- The markets responded favorably to the Fed’s decision and we think it was the right move. Historically, recessions have been caused (in part, at least) by the Fed raising rates too high/too fast and taking a cautious approach has always been what we prefer to see. As such, asset classes like Utilities, REITs and bonds have enjoyed a bit of a bounce in the last few weeks.
- There has been a lot of buzz around the “inverted yield curve” as a sign of a coming recession – that can be an indicator, historically, however it is not the be-all-and-end-all of an indicator, and there are reasons to think that in this market cycle, given that inflation is still historically low, we shouldn’t get overly excited about something that the public market loves to get worked up about.
- Despite 2018’s disappointing 4th Quarter numbers, we still enjoyed a solid year of ~3% growth in Gross Domestic Product (GDP) – however, much of that growth was due to one-time effects driven by the Tax and Jobs Act of December 2017, and so we expect to see some of the positive effects of that start to dim in 2019-20. What the TAJA did do, however, was effectively increase consumer cash flow and that is not something that will go away any time soon. The demographic trends of the US population (retiring baby boomers) will put pressure on GDP over the next few years of this cycle and our expectation is to see GDP fall to somewhere in the mid-to-low 2’s in 2019 – and to see it around 2% in 2020. A positive GDP number is very often an indicator of positive S&P500 return for a given year, so even though GDP may be declining, if it is a positive number, we don’t see a reason to head for the hills at this point.
- Another indicator, the US Unemployment Rate, continues to be in fine shape as we are still at relatively historically low levels – 3.8% in February.2 And even though wage increases have come up a bit in recent months, we think they will likely level out over the next few months as they are still below, but approaching, the 50-year average of 4.1%.
We continue to favor dividend-generating and dividend-growth (ie stocks growing their dividend payout rate) stocks, which we access in a variety of ways on a portfolio-by-portfolio, client-by-client basis. We think, especially given the Fed’s decision to pause on rate hikes, inflation is very manageable at this point.
- Core CPI has been remarkably stable, at 2.1% in February, and we think there are reasons to expect it to remain more-or-less in that area.3 Tariffs and trade wars are continuing to keep the dollar up relative to other currencies, which ought to provide a tailwind to global equity holdings in dollars. Tariffs and the trade wars are also putting pressure on major global exporters, including Germany, Japan, Taiwan, Korea, but US policy continues to be somewhat frenetic. Heading into the 2020 electoral cycle, President Trump has not indicated any intention to declare victory over the Chinese, but if these global pressures continue to put pressure on the US economy (as we saw in Q4), that may change as politically, that would hardly be advantageous.
- On other political matters and potential trade issues, the NAFTA replacement, the USMCA treaty, will be working its way through the US House of Representatives. There is strong push back for political and economic policy reasons on the proposal, but there are questions as to whether the House Democrats will wish to be seen as obstructing the President’s policy/trade treaty proposal. We think it is a coin flip as to whether that treaty is ratified, and if not, there is cause for potential trouble if the President, fond as he is of brinkmanship, refuses to renegotiate. We absolutely think that NAFTA is worth updating, and a lot of the leg work to do so has been done, as both parties acknowledge the need to do so. The question is whether both parties can agree on the best policy outcome of a deal.
- Finally, with respect to fixed-income, we continue to hold short-to-medium term bonds. We believe rates will rise, but at this point, it looks like this rate rise is not in the near term. Regardless, the additional income a longer-term bond pays does not offset the risk of rate hikes – now, or soon. So, we remain in the shorter-term range for now. The Fed’s decision to hold off on increasing rates makes the fixed income market a bit more manageable, but we continue to watch this space carefully.
- Protecting equity will continue as we progress late into this market cycle to be a major factor in our portfolio construction methods.
There are a lot of challenges to the markets today. The increased political rhetoric, China, immigration to name a few, cannot be dismissed. However, from an economic standpoint, much of this is noise in the background of an economy doing well, even if it has been doing well for several years. We are aware the market often resets in 10-year cycles but feel the “noise” has exposed the markets for being resilient lately. We do not make light of the issues this country faces lately, but in the long term, many issues handle themselves through the economics involved and we strive to keep perspective in a time where the noise can drown out the big picture.