MARKET BRIEFS: Q1 RECAP AND Q2 OUTLOOK

More Likely a Whimper Than a Bang   |   Market Review Q1 2019   |   Turning the “Inversion” Story Upside Down

A strong quarter for US stocks

The US equity return for the first quarter was 13.65%¹ continuing the impressive gains of the last several years (the trailing 3-year annualized return for US stocks was 13.51%²).

Perhaps because of the strength and the sheer longevity of the current rally, many advisors are probably fielding questions from clients about when the rally will end, and whether the end will come with a 50% drop from its peak value (similar to what investors experienced in 2008 and 2002) or with a more typical 10%-15% bear market decline. While we think the latter is more likely than the former, we believe such discussions aren’t useful outside the context of an investor’s capacity and tolerance for risk.

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¹ S&P 500, Source: Morningstar, as of March 31, 2019
² Ibid

• What a difference a quarter makes. Markets reversed course and ‘settled up’ as risk assets led the way. Global equities returned 12.3% (MSCI ACWI) for the quarter while global bonds returned 2.2% (Bloomberg Barclays Global Aggregate). Global REITs outperformed global equities and returned 14.3% (Dow Jones Global Select REIT) for the quarter.
• Within equities, US markets led the way with a return of 13.5% (S&P 500), outperforming international developed markets and emerging markets which returned 10.1% (MSCI EAFE) and 10.0% (MSCI Emerging Markets) respectively.
• The US markets had their best start to the year for over 20 years as growth factors outperformed led by technology which was the best performing sector for the quarter at 19.9% (S&P 500 Sector Information Technology). Healthcare saw the weakest return at 6.6% (S&P 500 Sector Healthcare), having been the market leader in 2018. Concerns from the upcoming primary season along with mean reversion were likely drivers of the weakness seen in Healthcare.

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The story
On March 22, 2019, the yield curve “inverted” (short-term rates higher than long-term rates) for the first time since 2007. Most of the time, bond investors demand additional yield to bear the increased risk of bonds with a longer maturity, leading to an upward sloping yield curve. But as the economy moves later cycle and the Fed increases rates to prevent the economy from overheating, the yield curve has tended to flatten. Yield curve inversion has preceded the last 7 recessions, leading to concerns that the March inversion indicates that the economy is now headed for recession.

The reality
The yield curve is not an independent measure of the economy or even a pure expression of investors’ expectations about the future – strictly speaking. It is a function of the current supply (for sale) of, and the demand for, government bonds. The buying and selling reflects monetary policy (driving short maturities) and expectations about the future (driving longer maturities).

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