The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Geopolitics dominated headlines throughout the week, as a sudden re-escalation of trade tensions between the U.S. and China forced global equities into one of their first weeks of solid losses all year. The S&P 500 shed a little over 2% of its value through week’s end, with international markets losing a bit more.

Despite appearing to be close to a final deal which would have enabled business leaders and markets to put much of the trade-related uncertainty behind them, Chinese officials reportedly backed away from multiple concessions they had made during prior negotiations. Chief among them were issues related to Chinese government subsidies, which have historically served to tip the competitive balance in favor of Chinese companies. In response, President Trump drew a hard line and raised tariffs on $200 billion worth of Chinese exports, effective immediately.

Elsewhere, diplomatic relations between the U.S. and Iran deteriorated to their lowest level in years after a U.S. aircraft carrier was deployed into the Persian Gulf in response to indications of potential planned attacks on U.S. interests in the region. Oil prices have inched higher as a result of the rising tensions in the region.

Amid all of this geopolitical “noise,” it is important to remember that long-term growth in equity markets is driven by earnings, which are far more connected to the strength of the consumer and the economy than to the patterns of global trade. Both the economy and the consumer remain on firm footing at this point in time.

Chinese Economy a Double-Edged Sword
It seems that at present, any new information regarding China’s economy may be a double-edged sword. During the later end of 2018, the data coming out of China seemed to suggest that its economy was weakening, and there was speculation that the weakening economic momentum was at least in part due to U.S. trade policy. The prospects of a weakening Chinese economy were among the list of factors blamed for the market volatility during that time, just as the subsequent inflection point was considered one of the keys to the 2019 rally. The problem for markets is that China’s improving economy may have emboldened its leaders during last week’s trade negotiations, perhaps setting the stage for the setback in negotiations.

Investors are now faced with a difficult proposition regarding China. On one hand, the improving Chinese economy is good for global markets, and bodes well for extending the global economic cycle. On the other hand, it provides Chinese negotiators with more leverage during trade negotiations, which makes it much harder for US officials to reach a satisfactory deal.  As we have seen, markets are very sensitive to meaningful shifts in the expected probability of a final deal being inked, but since market performance tends to mirror the health of the global economy and not trade patterns, long-term investors should place more emphasis on the economic data when positioning portfolios.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
A Friday rally (triggered by a very strong April jobs report) helped markets finish the week with modest gains as investors focused heavily on resumed trade talks between the U.S. and China, as well as the Fed policy-setting committee meeting. Markets were slightly disappointed by the news coming from both China and the Fed, and that weighed on sentiment throughout the week despite some positive earnings surprises from major companies. 

Too Much, Too Fast?
The S&P 500 has rallied more than 25% from its closing level on December 24, 2018. During that rally, there have been precious few opportunities for those who moved to the sidelines during the market turmoil to jump back into the fray. And while the market has resembled a swinging pendulum over the past eight months, investor sentiment has oscillated just as much. Ned Davis Research tracks a number of data points in an attempt to measure the magnitude of investor sentiment, and recently reported that sentiment has shifted into the realm of “excessive optimism.” Readings such as this are typically viewed as a contrarian bearish signal. 

It is rather remarkable for sentiment to move so wildly in just a few short months (that same sentiment indicator was signaling “excessive pessimism” back in December), and investors should be cautious about chasing the rally at this point in time. We believe that at current market levels, a near-term pullback would likely be helpful in resetting investor expectations and would present an opportunity for investors looking to move some cash back into the market.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
U.S. equities posted small gains for the week, but they were enough to enable the S&P 500 to reach new all-time highs on Tuesday and again on Friday. Markets were bolstered by a stronger than expected first quarter GDP reading, which indicated that the U.S. economy grew at an annual rate of 3.2% despite the government shutdown and harsh winter weather. However, many economists have noted that the strong reading got a big boost from very favorable net export numbers, which can be quite volatile. It would be unsurprising to see a material shift downward during Q2 if import/export activity exhibits a reversion to the mean. However, at the very least, investors should take the Q1 GDP data as a signal that growth is not stalling, which is a far cry from the concerns that dominated sentiment in 2018.

The Market Recovery Is Complete
After reaching new all-time highs last week, the market has completed its recovery from the volatility experienced during the end of 2018. While there are a variety of factors that helped to push markets back to all-time highs, the most significant was that the economy remained resilient. The fears of a protracted slow-down that dominated Q4 2018 never truly manifested in the way that many anticipated, and the GDP data from last week has helped to confirm that these fears may have been overblown. The chart below shows the quarterly US GDP readings dating back to the 1960’s. Recent economic growth in the U.S. has remained robust and has now pushed beyond the historical average rate of 2.8%. While growth in the U.S. is unlikely to remain at the current level forever (for reasons touched upon above), we are not yet seeing signs of the recession many had feared was on the horizon just a quarter ago.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Global equity markets inched higher in the holiday shortened week (markets were closed on Friday in observance of Good Friday) amid a slew of economic data that surprised to the upside. March retail sales figures came in stronger than expected and showed a strong bounce back from a weaker than expected February. Additionally, jobless claims fell to their lowest level since 1969.  Bond yields crept higher throughout the week, with the 10-Year Treasury yield touching its highest level in over a month.  The move was likely fueled in part by the positive economic data triggering some optimism for economic growth.

As of the end of the week, about 15% of S&P 500 companies had reported Q1 earnings results, with 78% of them reporting positive EPS surprise. Even so, according to data collected by Factset, the blended earnings growth rate for those companies that have reported is -3.9%. The high incidence of positive surprise combined with the relatively uninspiring growth rate reflects how low expectations were coming into Q1 earnings season. We will continue watching as more companies report results and we get a fuller picture of corporate profitability during the beginning of 2019.

2019: The Year of the IPO
2019 is set up to be a particularly active year in the IPO (initial public offering) market. Before year’s end, disruptive companies like Uber, Airbnb, and WeWork are expected to join Lyft, Pinterest, and Zoom on the list of large tech firms making their public trading debuts this year (Pinterest and Zoom both debuted last week and Lyft completed its IPO back in March). Many investors have been clamoring to get into these trendy names, but others have been quick to point out that the flurry of activity may be a sign of overexuberance in markets. In any case, as with any investment, the general rule of thumb for investors interested in buying shares of a stock that recently debuted on an exchange is to do your research. The power of FOMO (fear of missing out) can be particularly fierce when it comes to high profile companies, especially as the financial news outlets are perpetuating stories of huge gains for early investors. But that’s just the thing, those huge gains that pundits like to talk about were available to only the earliest investors and have already been realized. Any new investment needs to be evaluated through the lens of the current price, as the price you pay for an investment is the single most important factor in determining success.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Most major stock indexes posted small gains for the week, with U.S. stocks (as measured by the S&P 500) slightly outperforming their international counterparts. Q1 earnings season officially kicked off with some high-profile earnings beats, including encouraging results from Walt Disney and JP Morgan. The current earnings season is being tabbed as one of the more important in recent years, as analyst surveys have pointed to a general expectation that corporate profits may actually post negative growth when compared to the data from Q1 2018. The expectations for limited earnings growth stem from two primary factors. First, the benefits of tax reform are no longer boosting the year-over-year comparison since companies now are likely to have the same effective tax rates as last year. Secondly, rising wages and raw materials costs are putting downward pressure on profit margins. Across the market, analysts are calling for 5% growth in revenues, but for that growth to be offset by increases in the cost of doing business.

Labor Market Remains the Strongest Aspect of a Still Healthy Economy
On Thursday, the Labor Department reported that weekly jobless claims had fallen to their lowest level since 1969. Jobless claims are reported as an absolute measure, meaning that they are just a running tally of total new claims for unemployment insurance. What makes the most recent measure particularly impressive is that the last time jobless claims were this low, the labor market (total eligible workers within the economy that are either working or looking for work) was only 60% of its current size. The labor market continues to be an area of strength for the U.S. economy, and the Fed has made note of this in recent meeting notes. In fact, the minutes from the Fed’s most recent policy meeting were released on Wednesday and made specific reference to the tightness in the labor market, pointing out that it was “noteworthy” that the health of the labor market has not led to higher inflation.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
U.S. stocks posted another week of solid gains, and the S&P 500 now sits within 2% of its all-time high (previously established in September 2018). Much of the market’s gains appeared to be influenced by some better than expected economic data from the Chinese manufacturing sector, as well as a strong March U.S. jobs report which revealed a significant recovery from a disappointing February figure. Interestingly, what many might expect to be one of the more significant sources of uncertainty – the Brexit negotiations – have largely had little impact on markets so far in 2019. Having already extended the deadline for a deal, British Parliament still appears to be no closer to a resolution than it was a few weeks ago.

In the bond market, the reassuring economic data helped to restore the yield curve to a more traditional upward slope over the three-month to 10-year range. Yields in the middle range of the curve crept higher, but remain well below their highs.

Retirement Bill Passes in U.S. House of Representatives
In a rare (and perhaps surprising) display of bipartisanship, the Ways and Means committee of the U.S. House of Representatives voted in support of the SECURE Act, a bill which will provide some positive new changes for those currently in the process of saving for retirement. The bill seeks to provide enhancements to the available tax breaks for retirement savers, as well as increase the incentive for more people to participate in employer sponsored retirement plans such as 401(k)s. If eventually passed into law, the bill would repeal the maximum age for traditional IRA contributions (currently age 70 ½) and increase the age for required minimum distributions from 70 ½ to 72. Additionally, long-term part-time workers would be allowed to participate in 401(k) plans, and small employers would receive expanded tax credits for creating retirement savings plans for their employees.

Quarterly Commentary – Q1 2019

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Equities:

Equity markets bounced back from a tumultuous end to 2018 with one of the strongest quarters in recent memory. Remarkably, the upward momentum in equities was established despite further weakening of the economic backdrop, a lack of real progress in US/China trade negotiations, and the longest government shutdown in US history. So what changed? For one thing, the market likely overshot to the downside when it teetered on the edge of bear market territory back in December, but markets also received a shot of adrenaline from the Federal Reserve, which completely reversed course on its plans for monetary policy normalization.

The market rally during the first quarter has helped to illuminate just how fixated the market has become on the Federal Reserve. The roots of that fixation likely trace themselves all the way back to the financial crisis, when interest rates were pulled down to zero and the great policy experiment known as “Quantitative Easing” began. For ten years now, the market has become accustomed to the artificially high levels of liquidity and easy access to capital that these policies have fostered, and it is becoming apparent that it will take time for markets to be weaned off of that support. All of this has put Fed Chairman Jerome Powell in an unenviable position, where every public appearance he makes has the potential to invoke a meaningful response from markets.

Bonds:

Performance in the bond market was also strong to start the year, as a downward shift in inflation expectations combined with the reversal in rhetoric from the Fed to push yields to their lowest levels since 2017. However, bond yields flashed a bearish signal to markets during the last few weeks of the quarter as the yield difference between the 3-month T-Bill and the 10-year Treasury Note inverted (the yield on the longer dated 10-year note moved below that of the 3-month T-Bill). The inversion has prompted many to point out the historical relationship between yield curve inversions and economic recession, but we believe this is overblown.

The yield offered on US Government bonds is largely dependent upon expectations for economic growth and inflation, both of which have moved lower over the past 6 months.  However, at this point in time the US economy appears to be slowing rather than stalling. Expectations for economic growth remain around 2%, which could still provide a stable environment for investors to generate modest returns. In a low inflationary world, modest returns should still be enough to keep investors on track for their long-term goals.

Outlook:

Much of our review of the first quarter has been focused on the Federal Reserve and monetary policy, which remains a key area of focus for markets. But as the calendar rolls over into spring, markets may shift their focus to Q1 earnings, which are expected to be quite a bit lower than in 2018. The extent to which earnings exceed or miss expectations could be a key driver of market performance in Q2.

Furthermore, while President Trump has signaled that he is generally pleased with the progress that has been made with respect to trade negotiations with China, little tangible evidence of an impending deal has emerged. Recent data from Europe has highlighted the impact that the slowdown in global trade has had on the world economy, and this has been a source of unease for global investors. In our view, an eventual deal with China will be important to the extension of this bull market, as it would help to alleviate the concerns permeating through markets regarding the growth rate of the global economy. And it is these concerns that are at the core of the market’s anxiety over the future of Fed policy.

VIDEO: Q1 2019 Market Commentary – Connor Darrell CFA, Head of Investments, shares Valley National Financial Advisors’ review of the first quarter in 2019. WATCH NOW

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
U.S. equities (as measured by the S&P 500) posted another week of gains and closed out the strongest quarter since 2009 on a positive note. Investor sentiment toward the end of the week appeared to be bolstered by stronger than expected new home sales, which helped to calm fears about a weakening housing sector. The bounce back in the housing market may have been driven by the significant decrease in bond yields to start the year, which have helped push mortgage rates down well below their 2018 highs.

The sharp drop in bond yields over the course of Q1 has been largely driven by softening global economic growth and a shift in rhetoric from the Federal Reserve, which is no longer anticipating any more rate hikes during 2019. However, at some point the market’s primary focus will shift away from Fed Policy and Q1 earnings season will be one potential alternative. As companies begin reporting Q1 earnings, which are expected to be quite a bit weaker than in recent quarters, the market will need to grapple with whether the recent rally can be sustained despite weaker corporate profits. The extent to which corporate earnings exceed or miss these lower expectations may go a long way toward guiding market performance over the next few months.

Q1 Market Commentary Now Available
Our market recap for the first quarter of 2019 is now available on our website at valleynationalgroup.com/Q12019

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Four days of stable market gains were erased on Friday as renewed concerns over the trajectory of global economic growth weighed on interest rates and equities. Early in the week, the primary focus of investors was on the Federal Reserve, which opted to hold interest rates steady following its second policy meeting of 2019. During his post-meeting press conference, Fed Chair Jerome Powell highlighted recent moderation in U.S. consumer and business spending and cited a more meaningful slowdown in Europe. A summary of individual policymakers’ projections for the future of interest rates revealed a pronounced dovish shift in future policy expectations, and markets reacted positively. Eventually however, news on Friday morning that activity in the German manufacturing sector had fallen to a six-year low seemed to spark a broad market selloff that knocked stocks off of their five-month highs.

Watching the Yield Curve
Last week, the Federal Reserve signaled that it may leave interest rates unchanged throughout the remainder of 2019, and the news pushed bond yields to their lowest levels in over a year. Market prices now fully reflect the assumption that the Federal Reserve is finished with its tightening cycle and even suggest about a 30% chance of a rate cut in 2019.  The massive shift in expectations over the past few months has led to a more pronounced inversion of the yield curve, where the yield on a 10-year treasury has now dropped below the yield on a 3-month bill. We still believe that the probability of a U.S. recession in the near term remains quite low (though it is slightly higher than it was just a few months ago). Further, we caution investors against reading too much into the shape of the yield curve or using it as a trading signal. While the yield curve has historically been a relatively reliable indicator of future economic conditions and should still be monitored closely, we believe a broader view is warranted in the current environment. Monetary policy has played such a massive role in driving interest rates over the course of this economic cycle, that it may have clouded the signaling power of traditional indicators like the yield curve. As the Fed begins to moderate its approach to monetary tightening, perhaps some clarity will be restored. But in the meantime, we believe investors would be best served by sticking to long-term asset allocation targets and utilizing the market’s strong start to 2019 as an opportunity to rebalance back to those targets.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Equities posted healthy gains for the week despite a mixed bag of economic data and tempering expectations for Q1 2019 earnings growth. Market optimism seemed to be bolstered by reports from Chinese media outlets of progress in the U.S./China trade negotiations, as well as an easing of concerns over Brexit negotiations.

On the economic front, the housing and manufacturing sectors produced results that fell below consensus estimates, continuing a recent pattern of weakness. New home sales dropped by almost 7% in January despite the recent decline in mortgage rates easing affordability. Some of the weakness can likely be attributed to the government shutdown and poor Q4 equity market performance which may have eroded the confidence of potential buyers. On the positive side, January retail sales bounced back after a poor December reading and a preliminary gauge of consumer sentiment came in higher than expected. The mixed signals from economic data are typical of a late cycle environment.

Earnings and Prices Have Diverged
Equity investors have had a difficult time over the past 15 months. 2018 was characterized by very strong earnings growth and a healthy economy, yet the stock market performed poorly. This led to P/E multiples (where “P” refers to the price of stocks and “E” refers to corporate earnings) contracting as prices declined and earnings rose. Thus far in 2019, the opposite has been the case. The expectations for corporate earnings growth have deteriorated as global economic growth has subsided, yet stock prices have pushed higher amid a shift in rhetoric from the Federal Reserve and an evaporation of pessimism following December’s market bottom.

Over the long-term, earnings growth is a key input to determining the trajectory of the stock market, but throughout 2018 and 2019, the two have diverged. In order to justify continued multiple expansion, markets will likely require the support of some positive developments on geopolitical issues which have been a major source of uncertainty not only for investors, but also for business leaders. With last week’s news that British lawmakers voted against leaving the European Union without a deal in place, some of that uncertainty was lifted.  But the darkest cloud remains the ongoing trade saga between the United States and China. An eventual agreement that materially addresses the key concerns of U.S. negotiators and business leaders (who have had a difficult time making long-term investment decisions as a result of the uncertainty) could be the catalyst needed to move the ceiling for equities higher.