As fourth quarter 2018 came to a close, equity investors around the globe were tending to the wounds inflicted upon them by a brutal decline in stock prices. This decline was based on a growing concern the global economy was losing steam at a pace that, in combination with less accommodative monetary policy, would potentially lead to recession.
However, as the first quarter unfolded, investors became enthused that recession was not imminent. That enthusiasm, supported by dovish moves in monetary policy, propelled stock prices in the United States to their strongest performance since 2009. The Russell 3000 Index, one of the broadest measures of American equities, returned 14.0% for the three-month period. Outside the United States, foreign equity markets also turned in a strong performance as the MSCI EAFE Index, representing developed markets, returned 10.0% while emerging markets, as measured by the MSCI EM Index, returned 9.9%.
Strong equity markets are not the only story for the first quarter. As they say in television infomercials, “But wait, there’s more!” Monetary officials hit the “pause” button, interrupting moves designed to reduce the monetary policy stimulus that has been in place since the financial crisis of 2008-09. With this backdrop, bonds joined the positive return party as the Bloomberg Barclays Aggregate Bond Index returned 2.9% for the quarter.
Portfolios incorporating our full asset allocation were rewarded under the scenario that unfolded over the past three months. During fourth quarter 2018, we increased our exposure to domestic equities, funding the expansion with proceeds from a reduction in the exposure to fixed income. While both asset classes delivered positive returns during the quarter, equities were the dominant performer for the period as stated above.
In football terminology, a crackback is a block executed by an offensive player positioned away from the main body of the team’s formation who runs back in toward the formation after the ball is snapped. The “crackback” occurs when the offensive player blocks an opposing player inward toward the formation, hence, cracking back. The question that arises for investors given the strong performance of the financial markets in the first quarter is, “Will the markets ‘crackback’ to a more modest level of returns?” To answer that question, we’ll assess some of the factors that may potentially impact the financial markets in the months ahead.
In terms of economic growth, the United States experienced a deceleration in the rate of GDP expansion in the fourth quarter, slowing to a rate of 2.2%. For first quarter 2019, the consensus of economists surveyed by Bloomberg calls for further deceleration with growth falling to 1.5%. Sandwiching this outlook is a forecast of 1.7% from the Federal Reserve Bank of Atlanta and an expected increase of 1.3% from its counterpart in New York. Economic growth is anticipated to strengthen throughout the remainder of 2019, with Bloomberg’s survey forecasting 2.4% growth for the calendar year and the Federal Reserve (Fed) estimating 2.1%.
While recently released data has been decidedly mixed, we concur with the outlook for firmer, albeit modest, economic growth for the remainder of 2019. Supporting our outlook are ISM readings for both the manufacturing and service sectors that point to continued growth. The most recent reading of the NAHB Housing Index indicates positive sentiment from homebuilders and consumer confidence, as measured by the University of Michigan, which was stronger than expected in its latest reading and the strongest since October 2017.
Improvement is being seen in data from outside the United States as well. For example, several recently released indicators in China registered stronger than expected readings. These include measures of factory activity and unexpected increases in the private Caixin/Markit Manufacturing Purchasing Managers Index, as well as the country’s official Purchasing Managers Index.
About That Inverted Yield Curve
One of the significant events this quarter was the inversion of the U.S. Treasury yield curve based on three-month and 10-year maturities. Inversions based on these two maturities had not happened since 2007. This development led to numerous prognosticators calling for a recession to develop within the next 12 months. Their outlooks were based on historical precedent that inversions of this type occur about 12 months in advance of economic slowdowns.
We don’t currently share the outlook that a recession is imminent, as was reflected previously. The rationale for our viewpoint is we do not currently reside in an environment that has historically led to the “inversion/recession” causation conclusion. A key part of our viewpoint is the U.S. economy has already experienced significant slowing. Also, monetary policy has shifted away from multiple rate hikes by the Fed to speculation of rate cuts. The Fed has also shared that its balance sheet reduction process will not be as extensive as was previously expected. And finally, in today’s interconnected global economy, there are forces in place keeping borrowing costs low for the United States, which allows it to finance further growth at attractive levels.
Given the observations and outlooks provided above, we are maintaining our current asset allocation positioning that emphasizes an overweight in equities – specifically domestic equities – and an underweight to fixed income. As always, we encourage a periodic review of portfolio positioning to ensure proper alignment of holdings with stated goals, objectives and risk tolerances.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involved risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.