Only a few months ago, domestic stock markets were in a sharp decline. Last year ended with stocks in the red, as a turbulent fourth quarter dragged down annual returns. There’s a saying that time heals all wounds. In this case, investors did not need much time, as 2019’s equity market start has charted an exceptional reversal. Performance for the S&P 500 Index has been notably strong. The first quarter of 2019 has returned the most, on a standalone quarterly basis, in almost 10 years for the index. Moreover, the past quarter was the strongest opening quarter for a calendar year since 1998. As of our writing, stocks have nearly reached a six-month high. Naturally, investors with whiplash may find themselves asking what has changed to cause this remarkable reversal.
First, we have perceived a large shift in the anticipated path of short-term interest rates. In our last quarterly commentary, we described a hawkish Federal Reserve, poised to continue a program of increasing rates on the short end in order to “normalize” them. Indeed, the market consensus was that the Fed would continue to raise rates, returning them to higher historical levels. The stock market responded poorly; investors will recall that, during the last quarter of 2018 alone, markets declined by 14%. While we felt at the time that the stock sell-off was a bit overblown, the Fed has now reversed course somewhat, signaling a period of increased flexibility in its policy going forward. Rate increases by the Fed are no longer a given. Stocks have rallied.
It would be an oversimplification, however, to perfectly link the Fed’s recent actions back to stock market moves. The economic environment plays an important role in both the Fed’s decision-making and in the health and profitability of businesses. The domestic economic outlook continues to change and evolve. While the U.S. economy is still growing, that growth may be slowing. At 2.2%, GDP growth during the fourth quarter was lower than expected. Trade tensions continue to be front of mind. Globally, the political landscape remains uncertain, with Brexit unresolved as of our writing. While the stock market’s rally seems to have been unaffected by these factors thus far, they may partly explain why the Fed is backing off from aggressive rhetoric about rate increases going forward. At Clifford Swan, we are keeping our eyes closely attuned to the domestic economy. If growth persists, we anticipate healthy returns.
Lastly, you may have seen headlines that the yield curve inverted several weeks ago. The yield curve is a plot of bond yields versus maturities, and we normally expect an upwardly sloping line, where bonds with longer maturities reward investors with incrementally higher yield. This relationship typically holds in healthy economies, where we expect some level of inflation due to economic growth. Thus, a yield curve inversion, where the yields of longer-term bonds dip below the yields of shorter ones (changing the curve’s slope from increasing to decreasing) is often viewed as a predictor of an economic downturn. In the past, inverted yield curves have preceded recessions by about 18 to 24 months. However, this time around we see important differences. Interest rates have been so low for so long that we question the yield curve’s predictive power.
Going forward, we remind our clients to maintain a long-term focus through any additional market volatility. On a practical note, the shifting interest rate landscape has significantly decreased mortgage rates. If you have a mortgage on your home with rate of 4.5% or higher, you may want to consider refinancing.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.