U.S. stocks experienced a strong rally in the first quarter of 2019. The biggest performance driver came from the Federal Reserve pausing their interest hikes. Between 2017 and 2018 the Fed raised the Fed Funds rate approximately 8 times and until recently expected to continue raising rates into 2019. The sell-off in Q4 was largely attributed to the Fed moving too fast with interest rates combined with lofty stock valuations and a mild slowdown in economic activity. The Fed is also in the process of reducing their balance sheet by selling back the bonds they purchased during their QE program. They reached a level of $50 billion per month but have since slowed the program dramatically and expect to put it on hold soon. The Fed actions suggest that while the U.S. economy continues to improve, it remains in a fragile state.
Economically we are experiencing a mild slow-down as reported by Doug Short of Advisor Perspectives in his “The Big Four Economic Indicators”. For example, January Real Income experienced a sizable decline, but that was after 8 months of growth and followed December’s increase of 1.06%. Real Sales in February also dipped and 4 out of the last 11 reports have shown declines. Industrial Production appears to be pausing, with a combination of 2 shallow declines and one small increase during the last three months. Employment remains the shining star, but February almost reported a decline. Here’s a look at recent numbers (several reports for March and one for February still need to be updated).
In a report by State Street Global Advisors, they reported confidence of North American investors shows a slight improvement while confidence for European investors declined further. In the U.S. investors appear skeptical. In Europe they are faced with BREXIT and a host of other challenges, including violent protest in Paris.
Regarding all the talk about the Yield Curve inversion, we remain in an extremely low interest-rate environment which may reduce the predictability of a future recession a yield curve inversion has had in the past. The other factor to note is the long lead time between the inversion and the start of a recession (16 months since 1976).
We are at the beginning of Q1 corporate earnings season. As of last Friday, 25 companies have already reported quarterly earnings. Overall the market expects a decline in earnings compared to a year ago. However, as of April 5th industry analysts project a 8% price increase for the S&P 500 over the next 12 months according to FactSet. During the last 5 years analysts have overestimated their 1-year price target by 1.5%. The more constructive takeaway here may be the directional move versus the magnitude of the move, especially give the gains produces in Q1.
There are two developments currently working their way through the political process that could have a positive impact on the market. A favorable resolution to trade negotiations with China and talk of an infrastructure bill, potentially ready for a vote this summer. Positive developments in these two areas would go a long way toward helping the economy get back onto a stronger growth trajectory.
Overall, I feel pretty good about the economy and markets.
