Market Watch - April 2019
Written by Rick Welch
Changes from our January 2019 Market Watch are noted in italic.
US Large Cap Sectors –
Overweight – Health Care
Neutral – Communication Services, Consumer Discretionary, Consumer Staples, Industrials, Information Technology and Materials
Underweight – Energy and Financials (↓)
No Weighting - Utilities
US Mid and Small Cap – Maintain all weightings.
International Developed Markets – Maintain all weightings.
Emerging Markets – Maintain all weightings.
Alternative Strategies – Maintain all weightings.
We plan on increasing bond portfolio duration in 2019 to a level above 5.43 years, the current effective duration of the Barclays US Aggregate Bond Index.
Multi-sector Bond Funds – Maintain all weightings.
Investment Grade US Corporate Bonds – Maintain all weightings.
Convertible Bonds – Maintain all weightings.
High Yield US Corporate Bonds – Maintain all weightings.
Investment Grade Municipal Bonds – Maintain all weightings.
Data – During Q1, equity markets both here and abroad recovered from losses in the last quarter of 2018. For 2019, we see the following benchmark returns: US Large Cap – DJIA (+11.15%) and S&P 500 (+13.06%), US Small Cap - Russell 2000 (+14.17%) and International - ACWX (+10.27%). Economic data during Q1 was generally mixed and the 35-day partial US government shutdown caused the release of many data points to be delayed. Expectations for US corporate earnings growth have softened. GDP, the broadest measure of economic output, for Q4 showed an annualized growth rate of +2.2%, which followed faster growth in both Q3 (+3.5%) and Q2 (+4.2%). Volatility (as measured by VIX) declined throughout the quarter and finished at 13.77, below the long run average of 20.0. The Conference Board in reporting the February LEI (Leading Economic Index) said that “the US LEI increased for the first time in five months. This improvement was driven by accommodative financial conditions and a rebound in stock prices, which more than offset weaknesses in the labor market components.” During the quarter, the yield on the benchmark 10-year US Treasury declined from 2.69% to 2.41% and the yield curve inverted in March as the interest rate on three-month Treasury bills rose above the rate on 10-year Treasuries for the first time since 2007, prompting worries that the US is headed for recession later this year or in 2020. Monthly job growth averaged 212,000 in December, January and February as the national unemployment rate remained a low 3.8%. New weekly unemployment claims remained low, averaging 225,000 in Q1, compared to 217,000 in Q4. Consumer confidence, also measured by the Conference Board, was volatile during the quarter rising nicely in February only to fall back in March. The March Manufacturing Outlook survey (Philadelphia Fed) reported that “indicators for general activity, new orders and shipments returned to positive territory, while the indicator for employment remained positive.” Inflation, as measured by the change in the Consumer Price Index, came in at 1.5% in February and remained well below the Fed target of 2%. Lower single-family housing starts, falling new home sales, declining building permits and waning homebuilder sentiment all continue to impact the housing sector.
Outlook – At its March 19/20 meeting, the Federal Open Market Committee (FOMC) left its policy rate unchanged in a range between 2.25% and 2.5% and indicated that the rate will remain unchanged this year and only increase once in 2020. This forecast would bring the federal funds rate to a 2.5% to 2.75% range at the peak of this current cycle and appear to signal an end to the series of nine (9) rate hikes that began in December of 2015. One surprise in the recent Fed announcement was its decision to end its balance sheet reduction in September of this year and leave assets near $3.5 trillion or about 17% of GDP, much higher than expected. At a news conference following the central bank’s two-day meeting, Fed Chairman Powell said that “it may be some time before the outlook for jobs and inflation calls clearly for a change in interest rate policy.” It would appear that Fed policy is now neutral meaning the current rate environment should allow the economy to grow without pushing up inflation or slowing it down toward recession. This stance marks a clear pivot in Fed policy from that seen as recently as the December FOMC meeting. Some analysts have suggested that this remarkable and rapid change in Fed policy could lead to something even more surprising, perhaps a rate cut before the end of 2019. Why the dovish change in policy? Kathy Jones, Chief Fixed Income Strategist for Charles Schwab, may have said it best when she offered this recent assessment. “The tipping point for the Fed seemed to be the tightening financial conditions here and abroad. While the US economy is looking good, the US employment rate is low and consumers are in good shape, the cumulative effect of the Fed’s rate hikes to date have no doubt contributed to the global growth slowdown. The Fed is essentially the central bank to the world, because the US dollar is the world’s reserve currency. Consequently, when the Fed raises the risk-free rate it’s like a stone dropping into a pond – it ripples throughout the world, causing financial conditions to tighten.”
History suggests that yield curve inversions are often harbingers of tough economic times ahead. If we look back to 1969 (and the last 7 full yield curve inversions), we see that in each case an economic recession followed in about 14 months. Will this time be different? That is a very difficult question to answer and one for which pundits opine on both sides of the issue. There is no disagreement that an inverted yield curve when the US economy remains strong is a problem for the Fed. One assumption would be that short-term interest rates will decline either because the US economy slides into recession or the Fed takes preemptive action and lowers them in time to avoid a recession. What should investors do? For now, stay informed, be disciplined and watch the market. Adding to the dilemma is the fact that while recessions followed on average about 19 months after the last five yield curve inversions (1978, 1980, 1989, 1998 and 2006), in the year following the inversion the S&P 500 rallied, on average, +14.2%.