We thought we would bring you up to date on our outlook for the markets. While December unnerved many investors, the first quarter of 2019 brought renewed confidence. Q1 S&P 500 performance was the best in over 20 years. What happens next?
Where we are not worried:
- The markets dramatically oversold in December and then rebounded with similar speed. Neither the disconcerting sell-off nor the enthusiastic rally was probably fully warranted. Volatility is likely to continue – both to the upside and the downside. Without deep economic concerns, however, we believe that any downside volatility will primarily be short-term noise.
- Ned Davis Research says fund managers, margin buyers and hedge funds have been slow to embrace the rally. There could still be enough investors on the sidelines to extend this
- The underlying economy is decent, although growth is decelerating as the tax and spending stimulus of 2018 fades. The labor markets are strong, inflation is low, and the Fed has reasserted a dovish stance – declaring a temporary moratorium on interest rate increases. That takes the risk of a Fed misstep off the table for now and allows the economy to gain momentum.
- Predictions of a recession in the next twelve months are low. When markets correct or experience a bear market during a non-recessionary period, they usually rebound faster than during a sustained downturn in the economy.
What we are watching:
- The global slowdown. While the US doesn’t usually import recessions from abroad, our economic growth can be impacted by a slowdown overseas. Global economic production and growth figures are still quite weak. Tack on the Brexit conundrum and unresolved trade tensions with China, and there is enough uncertainty to put business leaders on hold in terms of their capital spending. This leads to earnings concerns amongst investors. Analysts are more optimistic, with some saying the rest of the world should show signs of recovery the second half of the year, which could spill over to US markets. However, enthusiasm is tempered and influenced by two caveats:
- The dollar. If the US economy weakens and we see stronger growth elsewhere, the dollar will likely fall. That is actually good news, since a weaker dollar helps our businesses export their goods overseas and increases the affordability of foreign debt denominated in dollars. However, if the US continues to be the best economy, then the dollar will likely get stronger, putting downward pressure on economies both here and abroad. We will be following the currency markets closely.
- The yield curve: economists like to say that recessions are usually preceded by inversions of the yield curve. That happens when short term interest rates are higher than long term interest rates. This can occur when the Federal Reserve is raising rates (as they have done 9 times since December 2015) and long-term bond holders are becoming more pessimistic about the economy. The yield curve (as measured by the three month Treasury bill to the ten year Treasury note) inverted in late March. This move sets the clock ticking for a recession to potentially occur in the next eighteen months. However, there are a number of analysts who are saying, “It is different this time.” The Fed’s low interest rate policy and extraordinary persistent weak inflation makes inverting the yield curve much easier. Most researchers we read are waiting for other indicators to flash red before putting the economy on recession watch.
- Politics: we have traditionally believed that politics has not been a big factor in market moves beyond headline risk. But economic politics – here and abroad – is dominating the news and can impact business and consumer confidence. Since economic growth is based on consumer and business spending, we are keeping an eye on what happens in Washington DC, London, and Beijing along with other nations’ capitals for political action that could spill over into the economy and influence investor thinking.
So what does this mean for the markets? We would like to believe It means more uncertainty without the need to panic. On the one hand, we feel the current economic recovery could last several more years and a soft landing could possibly avoid a recession this time round. On the other hand, we recognize that recessions can’t be avoided altogether in the long run. Wishful thinking should not replace pragmatism. For now, stay neutral on risk assets. Include some holdings that can benefit from economic growth as well as other holdings that offer downside protection. In other words, play it mostly safe, but don’t be afraid to include securities that will give you a chance to participate in a sustained rally.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.