The year started off strong with most major asset classes showing positive performance.[i] After the market volatility in the fourth quarter, most asset classes were able to rebound on the news of trade talks progressing between the U.S. and China[ii], the U.S. Federal Reserve pausing on interest rate increases[iii] and China adding stimulus to its economy[iv]. Generally, the stocks and asset classes that were the worst performers last year had the best performance in January and February.[v] The equity markets were led by the U.S. with mid cap and small cap stocks, followed by large cap stocks in the S&P 500.[vi] Emerging markets were positive with a wide range of performance with China domestic shares up 30%, but the index itself was up 9.8% for the quarter[vii]. International stocks also showed positive quarter up 10.2%.[viii] Bonds had positive performance for the quarter as we saw Treasury yields decline further in March.[ix] Commodities rallied with oil prices up 29% for the quarter.[x]
The U.S. markets performance has been sandwiched between technology and hyper growth companies and safer defensive sectors like utilities and REITs.[xi] The Nasdaq 100, which represents the largest technology companies, was up 16.5% for the quarter, while the technology sector as a whole was up 19.9%.[xii] Other sectors that rallied were energy and industrials, where we saw companies that were down significantly last year see a strong rebound.[xiii]
The fundamentals of the U.S. economy continue to remain robust with low unemployment[xiv], positive GDP growth[xv] and strong business activity[xvi]. We expect that first quarter data may be soft, given the 2018 Tax Cuts and Jobs Act (TCJA) and its related tax cuts, which boosted company earnings. Data may also be impacted by the 35-day U.S. federal government shutdown, and some inventory stockpiling due to recession fears and a number of winter storms.[xvii]. Most analysts are expecting 1.5% GDP for the first quarter and over 2% GDP for the year.[xviii] Earnings estimates are expecting an uptick in activity in the second half of 2019.[xix]
After a difficult 2018 and with slowing GDP growth in China, the Chinese government implemented a $1 trillion stimulus program during the quarter.[xx] At the end of March, manufacturing numbers showed that manufacturing activity is expanding again.[xxi] As a major global economy and trading partner, we are hopeful that China can stabilize and continue steady growth. In addition, China and the U.S. are continuing to negotiate on trade and we believe that both sides would like to reach an agreement.[xxii] At this point the higher proposed tariffs have been postponed, relieving those companies who would have been affected, as the impact would be a hit to earnings.
There are a number of competing stories in Europe. The most headline-grabbing is Brexit and what might happen. At the end of March, which was the official deadline, the UK was able to push out the deadline to mid-April.[xxiii] Prime Minister Theresa May has been unable to get agreement with Parliament on the terms of the UK leaving.[xxiv] Meanwhile, the EU is holding elections in mid-May and would prefer to have this resolved before then. [xxv] In France, the “yellow vests,” the disenfranchised middle class French population, has been holding weekly protests on high tax rates and the French government in general.[xxvi] Germany is facing economic weakness with its manufacturing sector moving into contraction territory.[xxvii] Some of their woes may be a result of changes in European emission regulations and having to clear out auto inventory.[xxviii] Overall it is expected that European GDP growth with be 1.3% for the year and there are concerns that Europe will stall out.[xxix]
Fixed Income/Fed/Interest rates
The U.S. Federal Reserve announced at the beginning of the year that they were pausing on interest rate increases this year; this pause was confirmed at the March Federal Reserve meeting.[xxx] With the dual mandate of full employment and inflation of 2%,[xxxi] the Federal Reserve believes that there is no need to raise rates right now. As a result, we have seen the 10 year Treasury yield decline, most notably at the end of 2018, but it has continued this year with the yield at 2.4% at the end of the quarter.[xxxii] This has also caused the Treasury yield curve to invert, where the 3 month Treasury yield is higher than the 10 year Treasury yield.[xxxiii] Historically, inversion of the yield has been one indication of the potential recession in the next year.[xxxiv] However, it should be noted that yield curve inverse typically coincides with other economic weaknesses, which we have yet to see. [xxxv]
Due to the declining yields, bond prices have been positive resulting in positive performance. Another factor is declining yields is that U.S. yields are among the highest in the world attracting additional fund flows.[xxxvi] Approximately $9.7 trillion of world bonds have negative interest rates currently[xxxvii].
After a big sell-off in oil prices in 2018, we saw a sharp rebound in 2019.[xxxviii] As a result, a number of oil companies had a strong first quarter.[xxxix] Another development that has caught our eye: oil companies are becoming more disciplined about managing cash flows and refraining from tapping the capital markets. Some of these companies are paying attention to their cost structures and are only drilling when it is profitable to do so.
The first big initial public offering of the year (IPO) occurred on the last day of the quarter. The ride sharing company, Lyft, which competes with Uber, went public at a $21 billion market cap.[xl] The company is not expected to be profitable in the near term as it is investing in fleet management and autonomous vehicles.[xli] We are expecting to see a number of high profile IPOs in 2019 including Uber, Pinterest, Slack, Palantir and potentially Airbnb.[xlii]
While some are concerned over the lengthening bull market, and some worry over interest rate curves, we still expect a positive year in the U.S. markets. We have seen a strong run up in the first quarter, which means we may see some volatility at times through the course of the year. However, the U.S. economy is in good shape and we are not seeing massive inflation, overconsumption, or over-investing, all of which are weaknesses that typically precede a recession.
Outside the U.S., there is a higher level of uncertainty and more geopolitical issues to contend with. However, the valuations outside the U.S. are constructive for investing in global markets if there appears to be stability and potential for a reignition of growth.
We continue to be positive, but cautious that sentiment or factors outside the U.S. could tip the U.S. markets. We remain focused on valuation and looking for new opportunities should they arise.