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.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
The major global equity indexes posted their worst week of the year as investor sentiment was impacted by further evidence of a slowdown in global economic activity. In the U.S., the monthly jobs number came in far lower than expected, though there is reason to believe that the report was heavily influenced by weather-related factors. In Europe, the European Central Bank (ECB) announced that it intended to inject further liquidity into the European banking system in an effort to curtail the negative impact that trade tensions and geopolitical concerns have had on economic growth. Lastly, the Chinese government seemed to unsettle markets when it announced a new fiscal stimulus program aimed at increasing activity in its slowing manufacturing sector. Bonds climbed higher as rates fell amid the flurry of new economic data and policy developments. 

The Pendulum Continues to Swing
At the beginning of December, the S&P 500 was trading right around the 2,790 level before negative sentiment drove the index to the brink of bear market territory. After a sharp reversal around Christmas and one of the strongest starts to a year in decades, the turmoil from December felt like a faded memory. But last week brought with it five consecutive days of negative returns for equity markets, leaving many investors wondering where we go from here 

It’s important to remember that market performance tends to track earnings over the long-term, and earnings are largely driven by economic fundamentals. The fact is that economic fundamentals simply do not reverse course so significantly in such a short period of time. As such, it makes sense to inquire as to whether the market was too pessimistic during December or too optimistic during January and February? The answer is probably yes on both fronts.

Given the heightened uncertainty and slower growth rates being observed around the globe (as compared to 2017 levels), the current fair value for the market is likely somewhere in between December’s bottom and March’s peak. The market seems to have attributed much of the recent slowdown in China to continuing trade tensions with the United States, while in Europe, the uncertainty of the Brexit situation continues to impact business investment and economic activity. Clarity on both of these issues is likely to be provided before the end of 2019, and this may allow economic growth to reaccelerate by the second half of the year. But until then, the pendulum may keep swinging back and forth with markets stuck in a bounded trading range. For investors, this is a period where patience and discipline will be essential. We continue to favor a disciplined approach to tactical rebalancing rather than attempting to time entry and exit points.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
Perceived progress in the ongoing trade negotiations between the U.S. and China seemed to keep an aura of optimism around equity trading last week, with developed markets equities (as measured by the S&P 500 and the MSCI EAFE indexes) inching higher. Bond yields also moved higher, with the 10-Year Treasury yield reaching its highest level in a month.

After a long delay related to the government shutdown, Q4 U.S. GDP was reported last week. The data showed that the U.S. economy grew 2.6%, which was above expectations but still below the trend rate that had been in place for the past two quarters. On the whole, the economy grew at a rate of 2.9% during 2018, up from 2.2% in 2017. 

Market Performance Diverging from Economic Data
The S&P 500 has posted its best two-month start to a year since 1991, even as economic data and corporate earnings have begun to taper off. While not necessarily poor in absolute terms, recently released economic data has been disappointing, with housing starts falling to their lowest level in two years and consumer spending declining precipitously. In the near-term, it is difficult to evaluate to what extent the uncertainty stemming from the government shutdown can be blamed, but thus far the Fed’s reaction (which has been to suggest that patience may be warranted in determining the path of future policy) has been celebrated by markets. 

It is likely not a coincidence that the market’s strong start to the year has coincided with a change in tone from the Fed. The expectation in the market is now for the Fed to hold pat for the entirety of 2019, which if recent trends are to be believed, would likely bode well for stocks. But as we observed during the latter half of 2018, sentiment can change very quickly.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
U.S. equities moved modestly higher last week, helped along by the release of the minutes from the most recent Federal Reserve policy meeting, which seemed to provide further evidence that policy tightening may be put on pause. Market sentiment has changed dramatically since the end of 2018, and the Dow Jones Industrial Average has now achieved its longest streak of weekly gains in nearly 25 years. However, economic data released last week was mixed, and many of the risks that concerned markets during 2018 still lurk.

International stocks outperformed their U..S counterparts despite rising uncertainty surrounding the potential fallout from a “no-deal” Brexit and some disappointing European manufacturing data.

Q4 2018 Earnings Update
Roughly 90% of companies in the S&P 500 have now reported Q4 2018 earnings. According to Factset, the blended earnings growth rate for those companies that have reported is 13.1%, a full percentage point higher than the estimates that were in place at the end of 2018. However, the data hasn’t been all rosy. During earnings calls, 68 S&P 500 companies have issued negative EPS guidance and only 25 have issued positive EPS guidance. Additionally, profit margins for U.S. companies are expected to show a year-over-year decline for the first time since 2016. 

As the economic cycle continues to mature, it is reasonable to expect a moderation in corporate earnings and profitability, especially when considering the uncertain macroeconomic environment (concerns over escalating trade tensions, Brexit, etc.) that global businesses have faced over the past several quarters. All in all, the first earnings reporting season of 2019 has brought no major surprises, and the double-digit earnings growth rate posted during Q4 is still a healthy one.

The Markets This Week

by Connor Darrell CFA, Assistant Vice President – Head of Investments
U.S. stocks posted positive returns for the eighth straight week despite unexpectedly disappointing retail sales data. Stocks were primarily supported by optimism that the U.S. and China might make progress on a trade agreement before U.S.-imposed tariffs are set to more than double on March 1. Bond yields jumped higher to start the week but reversed course following the weak retail sales data released on Thursday. Bonds ended the week relatively flat as a result.

Starting Point Matters
We have consistently warned of the potential perils of attempting to time the market, and the past few months have only served to lend further credence to those warnings. But that doesn’t mean that investors should not consider point-in-time analyses when evaluating their long-term strategy.  Following the tumultuous end to 2018, markets have rebounded considerably, and risks now look evenly balanced.  We continue to believe that while recent economic data has sent mixed signals to investors, the probability of a U.S. recession in the near-term remains low. However, the reality is that we find ourselves in what is very likely to be the latter stages of the economic cycle, and this fact carries long-term implications for investors. Given the stage of the cycle in which we currently find ourselves, investors need to be aware that the long-term expected returns across asset classes look quite a bit lower than they did in the past. The successful implementation of an investment plan is a dynamic process that responds to the market environment. As such, in an environment where market returns will be lower, investors may need to consider saving more or spending less in order to stay on track.