Stock markets across the globe rebounded sharply in the first quarter of 2019. The S&P 500 Index produced total returns of 13.7% during the quarter – its best quarterly performance since the third quarter of 2009. The two major concerns in the fourth quarter of last year were somewhat lessened as the Federal Reserve scaled back its plans to increase interest rates, and trade tensions between the U.S. and China moderated as negotiations advanced. While the S&P 500 ended the quarter just 3.3% below its all-time high achieved in September of last year, the other major indices shown below were still in correction territory at the end of the quarter – down more than 10% from their previous peaks. The strongest returns came in January and moderated throughout the quarter as stock valuations improved to reflect a more positive outlook.
The table below shows the performance of major equity indices for various time periods.
Equity Performance for Periods Ending on March 31, 2019
|Total Return Index||Market Sector||Quarter||1-year||3-year||5-year||10-year|
|S&P 500||Large U.S. Companies||13.7%||9.5%||13.5%||10.9%||15.9%|
|Russell 2000||Small U.S. Companies||14.6%||2.1%||12.9%||7.1%||15.4%|
|MSCI EAFE||Developed Int’l Markets||9.0%||-6.5%||4.3%||-0.4%||5.9%|
|MSCI EM||Emerging Int’l Markets||9.6%||-9.6%||8.1%||1.2%||6.4%|
The stock market correction at the end of last year reflected investors’ concern that the Federal Reserve was raising interest rates despite an apparent slowing of the world’s economy. In December, the Fed had raised its key short-term interest rate to a range of 2.25% to 2.50% and signaled that it planned to increase interest rates by 0.25% two more times in 2019. Although the U.S. economy was still on firm footing, growth in major economies such as Europe and China were showing signs of weakness. While the Fed’s dual mandate is to maximize employment and control inflation in the U.S., it has recognized in recent years that foreign economic conditions have a significant impact on the U.S. economy. As such, the Fed has more recently taken global economic conditions into consideration when making policy decisions. Taking into account the current weakness in major foreign economies and a lower GDP forecast for the U.S., the Fed is now indicating that it will pause on further interest rate increases in 2019 and that it will manage its balance sheet in a more accommodative manner. Many investors are now expecting an actual cut in interest rates by the end of 2019, as indicated by trading activity in interest rate futures.
Both the U.S. and global economies look weaker than they did a year ago. As a result, corporate earnings estimates have fallen significantly. Last year, analysts were forecasting approximately 10% growth for companies in the S&P 500 for 2019. Current consensus estimates for this year have fallen to just 3.1% growth, with some likelihood of an actual decline. On the positive side, the Fed is changing its current policy stance which should produce a lower interest rate environment that is favorable to equity investors and more supportive of economic growth. Though the Fed’s recent actions relieved some of the recession concerns, its inability to reach its goal of increasing interest rates to more normalized levels may itself be concerning, as it indicates the Fed has less latitude to stimulate the economy if conditions were to weaken further.
While the Fed kept its short-term rate unchanged during the quarter, investors saw longer-term rates decline, indicating lower demand from borrowers as the global economy appeared to be weakening. The decline in interest rates produced a rally for the bond market, as bonds with higher yields became more valuable. During the first quarter, the yield on the 10-year Treasury bond decreased from 2.69% to 2.41%. The Bloomberg Barclays Aggregate Bond Index, the broadest benchmark for the U.S. taxable bond market, generated returns of 2.9% in the quarter. We continue to regard long-term fixed income investments as relatively unattractive due to their low yields and the risk related to rising interest rates.
The trade skirmish between U.S. and China has begun to negatively affect global trade volumes and economic activity. However, the rhetoric between U.S. and Chinese leaders has generally moved in a better direction as both sides recognize the importance of making a deal. The U.S. has delayed its proposed tariff increases on several occasions with the hope of resolving the core issues soon. Considering that the U.S. and China are the two largest economies in the world, it is imperative that a mutually favorable agreement is reached soon to restore global economic confidence.
After declining to relatively low valuations levels during last year’s correction, stocks have returned to a fairly-priced range. According to Yardeni Research, the next twelve month price-to-earnings ratio for S&P 500 companies currently stands at 16.4, which is approximately equal to its average ratio for the past five years. Earnings are expected to show a year-over-year decline for the first quarter with gradual improvement as the year progresses. Large, U.S.-based multinational corporations are likely to see relatively strong domestic performance offset by sluggish foreign earnings, affected by global economic weakness and currency headwinds.
While we viewed the 2018 fourth quarter stock market correction as an overreaction to potential risks that could lead to a recession, we regard the just completed 2019 first quarter performance as a return to a more balanced perspective on corporate earnings expectations and the global economic outlook. The major positives are a relatively strong U.S. economy, low interest rates, low inflation, and stimulative central bank policy. The negatives are unresolved trade tensions, slowing growth in Europe and Asia, high levels of corporate and sovereign debt, and the potential for monetary policy mistakes by governments and central banks.
The stock market’s volatility over the past six months reflected a high level of uncertainty regarding the direction of the global economy. The investment process utilized by Vista to manage portfolios is not highly dependent on forecasting the future, since we regard this is an impossible task. We believe long-term investment goals can be achieved by maintaining an asset mix that is appropriate for an investor’s objectives and risk tolerance, utilizing diversification to control risk, and owning investments that are reasonably valued while offering attractive return potential.
John D. Frankola, CFA Lawrence E. Eakin, Jr. Matthew J. Viverette
Vista Investment Management, LLC is a Registered Investment Advisory firm. Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide information and analysis regarding investments and is not a solicitation of any kind. References to historical market data are intended for informational purposes; past performance cannot be considered a guarantee of future performance. Neither the author nor Vista Investment Management, LLC has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.