HIGHLIGHTS:
The S&P 500 rose to a new record high in April.
Domestic economic growth remains solid. Inflation remains low.
Global economic growth has slowed, but policy makers have taken stimulative actions.
First quarter earnings are easily stepping over a low expectations bar.
Odds of a China trade deal are high.
Via Nova’s outlook remains positive, but risks remain.
The S&P 500 rose to a new record high in April.
The S&P 500 rose to a new record high in April, helped by solid domestic economic reports, progress in the U.S. / China trade negotiations and comments from the Federal Reserve suggesting a steady interest rate policy at least through the end of the year. This persistent pattern of favorable interest rate, trade and economic developments is largely responsible for the strongest start to the year in over 3 decades.
The S&P 500 added over 4% in April and was led by a surge in cyclical financials, technology and consumer discretionary stocks. However, energy stocks were mostly flat for the month and healthcare stocks fell. We believe these two sectors could be in the political crosshairs as the 2020 Presidential election race intensifies; energy because of a desire to curb gasoline price increases and healthcare due to the Democrat’s push for a single-payer healthcare system. International and emerging market stocks also rose, but lagged U.S. equities, reflecting the slower economic growth in the rest of the world.
Aggregate bond returns were essentially flat in April as somewhat higher Treasury bond yields, a negative for Treasury bond prices and returns, were offset by narrowing credit spreads, a positive for corporate and high yield returns. Narrower credit spreads reflect improving confidence, a healthy economy and ample credit availability which are positive for the economic outlook. Bond yields are low by historical measures and will likely remain so over the near term based on the Federal Reserve’s decision to hold off on additional rate hikes while global economic uncertainty remains high. Low and steady interest rates are supportive of continued economic and earnings growth.
In other markets, inflation-related investments, such as gold, Real Estate Investment Trusts (REITS) and Treasury Inflation-Protected Securities (TIPS) fell. The value of the dollar rose again in April and increased 6% over the past year. A stronger dollar makes exports more expensive to overseas buyers and so is something of a headwind to sales and earnings growth for many large exporting companies. Conversely, the stronger dollar lowers the cost of imports for consumers and increases their purchasing power.
Domestic economic growth remains solid. Inflation remains low.
Here at home, the economic reports continued to point to solid economic growth this year with limited recession risks. The broadest measure of economic activity, GDP, surprised to the upside in the first quarter, expanding at over a 3% annual rate, while inflation pressures eased. This “goldilocks” combination of healthy growth and low inflation is favorable for both stock and bond markets; growth fuels company sales and low inflation supports low interest rates. In addition, employment growth was robust in the latest report lifting consumer incomes, confidence and spending following the end of the Federal government shutdown.
We believe the risk of a recession is very low for the remainder of this year into 2020. However, while the U.S. economy remains on solid footing in our view, repeating 2018’s strong economic performance could be a challenge for several reasons. First, the initial surge related to the tax cuts and stimulus will ease in 2019. Second, export growth has slowed in response to weaker foreign demand and trade tariffs. Finally, the uncertainty surrounding trade negotiations has made corporate investment decisions more difficult and has delayed numerous projects and initiatives.
Global economic growth has slowed, but policy makers have taken stimulative actions.
As we have stated previously, 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 challenge, but the adverse effects could be temporary if addressed over the near term 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 risks in the UK. Will Brexit pass or fail? Will it be “hard”? Will there be a new referendum? All of these possibilities create tension and risks as well as raise costs.
However, policymakers have taken steps to support growth. China stepped up fiscal stimulus through increased infrastructure spending and tax changes. The European Central Bank (ECB) adopted a more cautious tone and delayed planned steps to curb easy monetary policy. Japan maintained a similar easy interest rate policy. Our view is that these steps collectively limit the downside risks to recession overseas.
First quarter earnings are easily stepping over a low expectations bar.
Analysts expectations for corporate profits growth were very low going into the first quarter, due to slower growth here and overseas, the roll off or anniversary of the tax cuts, and the stronger dollar. However, with over three-quarters of companies reporting so far, earnings per share are easily stepping over a lower bar of investor expectations, which supports further stock market gains, given the healthy economic and low inflation backdrop. The first quarter is projected to be the trough for the earnings slowdown and profits growth is expected to accelerate through the remainder of the year into 2020, though it will be below the 20% gain in 2018.
Odds of a China trade deal are high.
While a final document has not yet been signed, Via Nova believes there is a strong chance of some form of trade agreement with China that would remove a major cloud that has been hanging over the economy and the markets for more than a year. Like most negotiations, however, compromise is often a crucial element to progress, and we do not believe the U.S. will get all the items on its wish list in an initial deal. Key elements that we see as likely include a significant reduction in the trade deficit with China, greater access to China’s financial markets, an increase in the number of U.S. majority-owned companies in China, a forum to address disputes on intellectual property, and some framework for the re-imposition of tariffs in the event of an agreement violation. We do not expect the iron clad protections for U.S. intellectual property demanded by Wall Street, as it might impose too much stress on China’s long-term economic development plans.
If such a deal is forthcoming, economic growth would increase and companies would have greater clarity on funding new investments. This combination should provide a meaningful boost to the equity markets in the coming quarters.
Via Nova’s outlook remains positive, but risks remain.
The increase in the S&P 500 to a new record high in April supports Via Nova’s positive outlook for economy and the equity markets. Several of the items on our Via Nova Worry Checklist have been or are being addressed, lowering the negative risks to our outlook. Currently, the risks of recession are very low, and we expect continued growth in consumer spending which supports further gains in sales, earnings and stock prices. Threats to the outlook remain, as always, but we see most of the potential negatives as self-inflected and avoidable, so that stocks can trend higher, albeit in a bumpy fashion. We are monitoring all the data and events closely for signs of notable deterioration and will adjust strategy as needed.