The Federal Reserve (the Fed) made a major reversal heading into 2019 following a rough December for stocks combined with softening economic data and weakening confidence. The Fed signaled it would end its three-year course of tightening monetary policy and adopt a patient wait-and-see stance on the future of interest rates.
At the same time, major central banks around the world also changed course, keeping borrowing costs low or, in some challenged regions, moving towards more stimulative monetary policies. This shift provided a substantial boost to the price of risk assets, and US equities had their best quarterly returns since 2009.
The rebound in risk assets, such as equities, commodities, high-yield bonds, or real estate, was also reflected in developed international and emerging market equities, which were hit even harder in 2018. Developed international equities fell more than 12% last year but recovered much of those losses, posting a year-to-date gain of more than 10%. Emerging market equities also recovered with prices rising nearly 10% so far in 2019. A primary catalyst for the recovery in both markets was the pivot in global interest rate policy, and in the case of emerging markets, considerable monetary stimulus in China.
While the risk of US recession appears low, uncertainties around geopolitical issues, trade policy, and the government budget could still weigh on investor and business sentiment.
2019 Q1 Returns
The first quarter saw positive returns in most markets, with US equities, international developed equities, and global real estate reaching double digit returns.
Top Factors Impacting Markets
The Fed’s pivot on monetary policy—moving from a tightening bias on interest rates to a patient wait-and-see stance—has played a role in investors’ preference shift seen in Q1 towards riskier assets such as equities and real estate, as well as the current confidence in sustained growth prospects for the economy through 2019. However, a reversal of this position due to inflation or other factors, could be a risk to the markets.
US Economic Activity
Tame inflation, low interest rates, improved sentiment, and optimism about a US-China trade agreement have all supported the continuation of our current 10+ year bull market run.
Several key reports released in the last quarter are contributing to more upbeat expectations. The Consumer Confidence Board Index for March came in at 124.1, slightly above the 120 number typically considered as confident.
In addition, the low unemployment rate, remaining at 3.8%, directly affects consumer confidence, which is constructive to the largely consumption-based US gross domestic product (GDP).
In housing reports, both new and existing home sales increased for the month of February, likely due to a fall in interest rates since late last year. The new home housing data has been mixed in recent months, but this report may prove to be the start of a more constructive trend.
International Market Trends
Developed Market Economies
Geopolitical tensions and softening global trade have weighed on growth in Japan and Europe, with Germany and Italy hit particularly hard. This deceleration of economic momentum in Europe has been reflected in a broad range of indicators, and the European Central Bank (ECB) recently slashed its 2019 forecast for full-year economic growth across the Eurozone from 1.6% to 1.1%.
One factor causing concern in the global markets is upcoming auto trade tariff talks between Europe and the United States. Automobile trade accounts for about 8% of total global trade so the impact of an escalation in these talks could be seen as a risk to European growth.
Following a slowdown in economic growth, the ECB reversed course last month, delaying a planned interest rate hike until 2020, giving banks ongoing access to cheap central bank funding. Some rates in Europe turned negative, meaning banks must pay fees to the ECB for parking their excess cash. The Bank of Japan (BOJ) is also continuing its stimulative monetary policy.
China made significant moves to restimulate its economy amidst the creeping trade war with the United States and a slowdown in growth. Measures include monetary easing, regulatory reforms, and a reduction of both value-added and social security taxes. A boost to Asian markets across the board occurred after China’s first official gauge for March, the producer manager index, exceeded forecasts. Also, the Fed’s pause in rate hikes is constructive for emerging market economies, which rely heavily on US dollar-denominated funding.
Bond market returns were strong in early 2019 after much volatility in 2018, but yields remain low by historical standards, despite four rate hikes by the Fed last year. The Fed, as promised, has remained patient on interest rates and equity markets responded. The first quarter S&P 500 Index return ranks as the best three-month performance since September 2009.
The yield on the 10-year Treasury Note declined since last October. While we’re seeing a flattening of the yield curve, which some economists view as cautionary, there’s a case to be made that buying on the long end of the US Treasury curve is a reflection of the highly competitive yield in the United States compared to other sovereign debt abroad.
Growth for the US economy in 2019 is likely to be slower than in 2018, reflecting the diminishing tailwind from tax cuts and continued policy uncertainties.
Despite expectations for slower growth, a recession in 2019 seems unlikely. The S&P 500 continues to trend positively, inflation is in line, the Fed is on pause and valuations aren’t reflecting excess investor optimism.
While prospects for developed international market regions could improve due to easier global monetary policy and the potential resolution of trade disputes, we remain mildly cautious. China is a significant trade partner for Europe, Japan, and Australia, so a possible stabilization in China’s economy would benefit those economies. An orderly Brexit and a favorable resolution to US-European auto tariff talks could help provide support for economic growth.
In emerging markets, risks and opportunities appear to be balanced, and the outlook for the rest of 2019 is encouraging. Near-term relief from US interest rate increases, Chinese policy stimulus, and renewed investor optimism around a trade resolution have set a favorable backdrop. The ECB and Bank of Japan remain firmly committed to providing monetary stimulus throughout 2019, which is supportive for emerging market equity prices as well.
While there are geopolitical uncertainties that could impact world economies, the back drop of some central banks moving toward a more stimulative monetary policy bias is constructive. We remain cautiously optimistic on the outlook for the rest of the year.
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