Stocks rebounded in the first quarter, but worries persist.

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  • The S&P 500 rebounded in the first quarter.

  • Global central banks adopt easier stance in response to economic and trade risks.

  • Q1 earnings expected to be flat to slightly lower but bottoming.

  • Our outlook is positive, but risks remain and can keep markets volatile.

The S&P 500 rebounded in the first quarter.

Stocks rebounded in the first quarter as key items on the Via Nova Worry Checklist for 2019 showed marked improvement, as we expected.  The top two items threatening the 10-year bull market have been the risk of excessive rate hikes from the Federal Reserve and global trade tensions, particularly with China.  Tangible progress on both fronts helped investors breathe a sigh of relief and return to the equity markets.  Risks remain, as always, but we believe the economy, corporate profits and stock prices could enjoy further upside for the remainder of the year.

The S&P 500 rose over 13% in the first quarter for the best start to a new year in two decades.  The economically sensitive technology and industrial stocks led the broad advance, suggesting an improved outlook.  The strength and breadth of the market rise was further reflected in the outperformance by small cap stocks after struggling last year.  International and emerging market stocks also rose but lagged the U.S. market, likely reflecting slower growth overseas.

Bonds were also boosted in the quarter by tame inflation reports and a decision by the Federal Reserve’s Federal Open Market Committee (FOMC) to remain “patient” in assessing the need for additional interest rate hikes, given the uncertainty surrounding the global economy and trade tensions.  The yield on the 10-year Treasury note fell below 2½% from a high of 3¼% in the fourth quarter pushing down home mortgage rates and giving a lift to the beleaguered housing industry.

In other markets, oil prices surged over 30% following the sharp fourth quarter decline.  Supply constraints in Venezuela, OPEC cuts, and expectations of additional sanctions on Iran all played a role in the price increase.  However, at $60 per barrel, oil remained below the peak 2018 highs of over $70 per barrel.  The higher prices helped boost energy stocks, which was one of the leading sectors in the S&P 500 in the first quarter behind technology and industrials.  Inflation hedges, such as and Treasury Inflation-Protected Securities (TIPS) and gold, lagged, while Real Estate Investment Trusts (REITS) outperformed. 

The value of the dollar continued to strengthen during the quarter, rising just over 1% and nearly 8% from a year ago.  A stronger dollar means cheaper imports for consumers, but it is also a headwind for companies that export and could be a drag on earnings for many S&P 500 companies in the first quarter.

Global central banks adopt easier stance in response to economic and trade risks.

Economic growth remained positive in the first quarter, but momentum slowed, particularly overseas.  The weakness was an important factor prompting central banks to shift to easier interest rate policies.  At its March FOMC meeting, the Fed confirmed its intention to hold off on further rate hikes this year.  While the Fed believes the U.S. economy is in a “good place” with a healthy labor market and low inflation, the uncertainty related to slower international growth and trade tensions could pose a potential risk.  The European Central Bank (ECB) also turned more dovish delaying plans to turn its policy more restrictive and suggesting that it may resume quantitative easing.  China, meanwhile, significantly increased fiscal spending on infrastructure.

However, analyzing economic health here at home was complicated by two factors.  The first was the record-long government shutdown which delayed the release of usual economic reports limiting available data.  The second factor was tactical business adjustments related to trade tariffs.  Companies often pre-ordered goods in advance of tariff increases causing a surge in one month followed by a decline in the next.  However, the information we have suggested a healthy labor market and high consumer confidence, which are key ingredients to continued growth in consumer spending.  In addition, small business confidence also remained high and hiring and investment plans increased.

Overseas, however, manufacturing surveys showed contraction readings in the EU, Japan and China in the first quarter.  Via Nova believes slowing economic growth outside the U.S. is due in part to a combination of several factors that appear to be either temporary in nature or one-off events.  These events do not suggest the typical cyclical imbalances that lead to recessions, but rather temporary headwinds to fundamentally healthy economies.  Resolution to these varied challenges could help firm international economic growth and support a rebound in foreign markets.  Trade tariffs are an important source of uncertainty over the near term, not only for overseas sellers to the U.S. but also U.S. companies trying to control costs and secure steady and reliable supplies for production.  However, the adverse effects could be temporary if addressed through successful trade negotiations.  Other issues dampening foreign economic growth include the diesel scandal with German auto manufacturers (a significant component of the German economy), the earthquake damage to nuclear power plants in Japan, protests in France and Brexit in the UK.  Still, we will continue to monitor these forces for signs of improvement or deterioration.

We believe U.S. economic momentum remains positive, and that the consumer is quite healthy and able to spend.  However, the combination of China trade tensions, slower growth in the EU, Brexit concerns and the fading aftermath of the record Federal shutdown have weighed on some businesses and prompted many to delay planned investment spending. 

Q1 earnings expected to be flat to slightly lower but bottoming.

Corporate profits are expected to slow significantly this year following gains of over 20% in 2018, but positive momentum is expected to return in the second half.  Three factors are cited as major reasons for the slowdown.  First is the “roll-off” of the tax reform tax cuts.  While the lower rates are still in place, the incremental benefit is less.  Second is global economic slowing, which curtails sales growth.  China, the second largest economy in the world behind the U.S., is frequently cited, but the EU is going through its own malaise.  Third, and partially related to the second, are trade tensions and tariffs.  Many analysts, including Via Nova, believe that the trade tariffs are a negotiating tactic to pull countries to the bargaining table and write more favorable trade terms.  However, that tactic is disruptive to global supply chains for many companies, increases costs and reduces foreign sales during the negotiating process.

Our outlook is positive, but risks remain and can keep markets volatile.

Via Nova’s outlook for the economy and the stock markets remains positive and was reinforced by the March employment data as well as the latest trade developments.  We believe the economy will remain in an expansion at least through the end of this year and into 2020.  However, the combination of a record-long government shutdown as well as the efforts by companies on both sides of the Pacific to minimize the impact of trade tariffs injected distortions and volatility into the economic data painting an alternating hot then cold picture of the economy.  While the data volatility is probably not yet over, the March employment report suggests that the dire recession predictions by some have been at best premature and we believe incorrect.

First quarter earnings growth will likely be flat from a year ago as the boost from corporate tax cuts hits its anniversary, but a reacceleration is likely in the second half of the year.  We believe investors and the markets are already sensing this improvement and have begun returning to the stock market, especially companies that have been adversely affected by trade and rising interest rates such as technology, industrials and housing.  We believe stocks can continue to rise as our positive outlook plays out in the coming months.

The outlook is not without risks, however, and we are monitoring them closely for signs of deterioration.  Our top worry of excessive Federal Reserve interest rate hikes appears to have been marked off the list, as has the record government shutdown.  A trade deal with China appears close at hand, though nothing is guaranteed when it comes to international negotiations.  Not surprisingly, markets have responded favorably to the positive developments. 

That said, there are other risks that may be more difficult to resolve completely if at all.  The House Democratic Game Plan aimed at building support for a 2020 presidential victory is off to a flying start and promises to generate a steady stream of provocative headlines that could keep investors nervous about specific sectors and about a major shift in policy.  Energy prices have been rising significantly in 2019, which is good for oil producers, but above $60/barrel begins to have a noticeable impact on gasoline prices and future inflation.  Corporate earnings guidance has been vague and uncertain during the trade negotiations, but the hope is greater clarity will return in the second half.  And while China trade talks are progressing nicely, trade talks with the EU have had limited success and could turn contentious later in the year.

The stock market tends to climb a “wall of worry.”  Significant progress has already been made so far in 2019, and we believe that stock prices can rise to new record highs later this year.