“Bull markets climb a wall of worry; bear markets slide down a river of hope.” – Anonymous
Review
The current bull market began its ascent just over a decade ago in March of 2009. The S&P 500 closed out the first quarter of 2019 at 2,834, which was a remarkable 2,158 points higher than its closing mark of 676 on March 9, 2009. This bull market is typical in that it has often “climbed a wall of worry,” a favorite saying among Wall Street veterans. The good news is high levels of investor skepticism are typically contrarian psychological indicators that accompany stock market advances. Despite the healthy rebound thus far in 2019, investor skepticism seems to still be elevated as a result of the dreadful stock market performance in the fourth quarter of 2018.
Many investors still seem to be concerned about the prospects of another 2008-2009 stock market decline. That concern was tested during the historic downdraft of the fourth quarter of 2018. However, a patient long-term approach to investing kept prudent investors positioned to participate in the strong market rebound in the first quarter. The S&P 500 was up over 13% for the first three months of 2019, which marked its best quarterly performance since 2009. The gains were broad based with all eleven S&P 500 sectors ending higher in the quarter for the first time since 2014. More notably, technology and industrial stocks lead the way along with energy stocks, as oil rallied from $42 per barrel at the end of 2018 to over $60 per barrel at the end of March.
The rally for the first quarter was supported and enhanced by three main factors: (1) a dovish Federal Reserve acknowledging it is not necessary to raise interest rates in 2019 due to slowing economies around the world; (2) increasing optimism that a trade deal will be reached with China in the coming weeks or months; and (3) an oversold market poised for a rebound if good news was received on interest rates and trade.
A majority of worldwide central banks are indicating they do not plan on raising interest rates any time soon due to the slowing pace of global economic activity. The recent decline in interest rates has surprised many investors and fixed-income managers. The bond market has basically done a round trip since the beginning of 2018 when the 10-year U.S. Treasury yielded 2.41%. The 10-year yield reached 3.24% in November, then declined to 2.68% by the end of 2018, and further declined to 2.416% as of March 31, 2019.
Before the first quarter closed out the yield curve inverted. This occurred because the yield on the 10-year Treasury note fell below the yield for the three-month Treasury bill. This was the first time the yield curve has inverted since 2007. An inverted yield curve signals falling growth expectations and historically can precede a recession within the next couple of years. But in the near term, the lower interest rates are resulting in lower mortgage rates that should help support the housing industry, and thus bolster the domestic economy.
Outlook
In late March, Federal Reserve officials indicated they are unlikely to raise interest rates for the rest of 2019. This is a significant change from the hawkish tone exhibited by the Fed in the fourth quarter of 2018. Traders are now anticipating a greater chance of the U.S. Central Bank lowering rates in the future rather than raising them. The Federal funds futures market shows about a 60% chance of the Federal Reserve lowering rates by the end of the year.
Economic growth in the U.S. will be closely watched for the rest of 2019 after a weaker than expected first quarter. It was not too surprising the economy slowed down in the first quarter of 2019. The strong holiday spending in late 2018 was followed by multiple winter storms and cold temperatures that potentially chilled consumer spending. However, the labor market continues to be strong, which could be a catalyst to stronger consumer spending. The labor market has added jobs for 101 consecutive months to notch its longest ever consecutive streak. The result of the strong labor market is a historically low unemployment rate. Employers continue to have a hard time finding skilled and qualified workers to fill open positions.
After a tremendous year for growth in profits for U.S. companies in 2018, analysts are expecting corporate earnings to only grow by modest single digits in 2019, according to FactSet. This is despite the expectation of a 3.9% earnings decline in the first quarter of 2019 for the S&P 500. If earnings do decline in the first quarter of this year, that would be the first decline we have experienced since 2016. The forward price-to-earnings ratio (P/E ratio) for the S&P 500 is 16.3 times. This P/E ratio is just below the 5-year average of 16.4 times, but above the 10-year average of 14.7 times. This is a reasonable valuation level even after the tremendous stock market gains in the first quarter of this year, particularly in light of the favorably low interest rate environment.
The three-month to 10-year US Treasury yield curve inversion that occurred in late March caused concern that it was an indication of an imminent economic recession and a possible bear market in stocks. The instant alarm and angst expressed by market pundits in the financial media was resounding. But data provided by the Bespoke Investment Group points out that in the year after the last four yield curve inversions, the S&P 500 was positive every time with gains of at least 9%.
We do not anticipate a recession happening in the near future. Interest rates remain low with no anticipated increase from the Fed anytime soon, inflation remains moderate, and the labor market remains strong. However, there are some risks for the stock market for the rest of 2019 that could trigger a decline, such as ongoing trade talks with China, uncertainty of the resolution of Brexit, and a further weakening in the global economy. Overall, we believe the positives outweigh the negatives. Therefore, we remain cautiously optimistic for the stock market in 2019.
Sincerely,
Marietta Wealth Management, LLC