April 2019

Q1-2019 Review

Q1 2019 saw the S&P 500 rally 13.1%. The yield on the 10-year Treasury, used as a reference rate for mortgage and many other rates, closed at 2.42% down from the 2018 year-end of 2.684%. Expectations of negative year over year earnings during Q1 are to be reported shortly. As the chart below illustrates, this has not happened since 2016.

The economy peaked in Q3-2018, as did the market, but the recession signal given by the nearly 20% SPX drop late in 2018, proved to be a false alarm. At 2867, the SPX is only 2.5% below its September 21, 2018 high.

While global economies show few signs of robust activity, the USA is still running GDP above 2% while inflation remains well below the 2% Fed target. 

U.S. retail sales slowed to +2.2% year over year in February versus +6.6% at the July 2018 cycle peak.

U.S GDP peaked at +3.0% in Q3-2018. Headline inflation peaked at +2.9% yr./yr. in July 2018. U.S Corporate profits also peaked in Q3-2018.

Last September economic forecasters expected 3 more rate hikes.

In early January, the Fed indicated it would be "patient" raising interest rates any further. Following the March meeting, Mr. Powell made an extraordinary pronouncement of "no further hikes in 2019." That was a rare occurrence of a Fed Chairman, reacting quickly to a slowing economy.

Some countries in the developed world again have negative rates out to 10 years, including Germany -0.05%, Switzerland -0.41%, and Japan -0.08%.

In an unusual late cycle pairing stocks rallied, while bond yields fell as Fed ease trumped recession fears.

Markets now forecast rate REDUCTIONS for later this year. Larry Kudlow, economic spokesmen for the Trump team, is calling for a 50 basis point reduction which again is very unusual.

In January, the markets declared "Don't fight the FED!" Central bank actions have dominated this entire 10-year cycle from the generational March 2009 bottom of SPX-666.79. When markets plunge central bankers react with lots of stimulus.

In 1966, economist Paul Samuelson famously said, "the stock market has forecast nine of the last five recessions." In 2018, the market got the forecast wrong again as the Fed changed course.

So far this year, we see no recession on the horizon, but we are seeing some smoke from this global slowdown.

The yield curve inverted, that is to say the 3-month Treasury yield exceeded the 10-year for the first time since 2006. While this can be an early indicator of a future recession, it is unlikely this situation remains the case for long, particularly if the Fed lowers rates later in 2019.

Copper prices stayed firm as the yield curve deepened and oil rallied past $60/bbl, both indicating a stable economy. West Texas Crude rose 32% in the quarter. This does not happen just before impending downturns.

As of April 1, the 2-year Treasury yield is 2.32%, while the 10-year is 2.48% not a very steep curve, but not inverted. Again not a recessionary sign. Long term rates are normally higher than short ones.

The Fed may have gone too far with their December 2018 rate hike. Soon after spooking the markets they clearly moved to the side of a more liberal monetary policy.

At current U.S.and global debt levels, central bankers and the political powers that be, really can't afford much higher rates due to record levels of government debt.

Strong sector performances last quarter included technology, utilities, REIT's, and oil.

Financials lagged badly, as banks prefer a steep yield curve and a strong economy.

China the world's second largest economy has begun to ease domestic credit policies, lower taxes and engage in serious trade negotiations.

European stocks and their economies still lag on trade concerns, Brexit uncertainty plus a strong U.S. dollar and weak local GDP's.

History indicates we may see more stock market gains in 2019 after such a strong start and future Fed policy ease.

Trade negotiations that are reportedly going well, could derail this rally if they fail. This is our main concern.

Now we await earnings reports for future guidance. FactSet sees a Q1-2019 earnings decline of -3.9%, the first year over year drop since Q2-2016. They estimate a forward SPX 12-month P/E ratio of 16.3X, below the 5-year average of 16.4x, but above the 10-year average of 14.7x.

Finally, VIX or the volatility index is back to 13.40 above last August's 10.17, but well below the spike of 36.2 we saw late December 2018. This indicates a calmer market environment, which attracts investors to risky assets.

Happy Spring!


Disclaimer: These stock market observations are confidential and proprietary. They are for informational purposes only and are not intended to be used, and may not be used, as investment, legal, accounting, tax, or other advice. No express or implied representation or warranty is being made with respect to their accuracy or completeness. No obligation exists to inform the recipient when the information herein is no longer current or accurate. These observations do not constitute an offer to sell or a solicitation of an offer to buy any securities or interests in any investment vehicles managed by CFA or an associated person or entity, or to provide investment advisory services.