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April Market Update

Stocks rebounded strongly in the first quarter thanks to a combination of improving U.S.-China trade relations, the Federal Reserve halting interest rate increases, and a better outlook for corporate earnings. The S&P 500 finished the first quarter of 2019 with the best quarterly return since 2009.

Starting with U.S.-China trade negotiations, significant progress was made towards a new deal over the past three months, highlighted by the removal of the March 1st trade deal deadline imposed by the administration back in late November. Most of that progress occurred in January and that was one of the initial catalysts for the first quarter rally in stocks.

Turning to the Fed, perhaps the most impactful event of Q1 was the Fed meeting that took place on January 29th and 30th when the Federal Open Market Committee opted to hold interest rates steady, but also stated that it would be “patient” regarding further rate increases. This shift, which according to the Fed was in response to global economic uncertainty, helped extend the markets’ gains from early January. The expected “pause” in rate hikes was later confirmed by the Fed at the March meeting as official projections for interest rates (known as the “dot plot”) showed no more rate hikes are expected in 2019. The Fed keeping interest rates steady should relieve pressure on the economy, and we have already seen some positive effects of that move via a decline in mortgage rates and a rebound in housing sales in the first quarter.

Finally, on a corporate level, earnings results were better than feared in the fourth quarter of 2018. We can see that most clearly in the market reactions to companies that posted disappointing earnings results. According to the research firm FactSet, S&P 500 companies saw the best stock price reaction to negative earnings per share surprises in nine years. Companies that missed analysts’ earnings expectations, on average, fell just 0.40% during the most recent reporting period, compared to an average 2.6% decline over the past five years. Additionally, more than 70% of S&P 500 companies reported earnings that beat estimates, while over 60% of companies reported stronger than expected revenues. Put plainly, an elevated number of bad earnings results were expected by the markets, and the lack of a continued decline in stocks with disappointing earnings implies the results were not as bad as feared.

However, while there was clearly more good news than bad during the first quarter, it would be a mistake to think that the economic “coast is clear.” As such, we think it would be premature to expect the second quarter to produce returns similar to the first quarter (as we all know, past performance is not indicative of future results).

While there was real improvement in U.S.-China trade negotiations, Fed policy outlook and earnings expectations, economic data in the first quarter was disappointing and continued to show a loss of positive momentum not just in the United States, but globally. The current estimate for first quarter GDP is 1.7%, well below the 2.2% growth in the fourth quarter. Internationally, European and Chinese manufacturing data showed outright contraction in activity in Q1, while continued Brexit uncertainty is acting as a headwind on the British economy.

Finally, many parts of the yield curve have inverted, meaning Treasury yields are higher on short term debt compared to longer dated maturities. In the past, that dynamic has sometimes preceded slower economic growth and lower inflation, neither of which are positive for stocks.

In sum, the market’s performance during the first quarter was a welcomed sight following the volatility and un-nerving declines in the fourth quarter of 2018. And, we are pleased to say there has been real improvement in the macro-economic outlook for markets, for the reasons listed above.

But while the outlook for markets has improved, notable risks remain. We continue to expect, and are prepared for, more volatility within the context of a still on-going, multiyear bull market.

The problems that contributed to the volatility in the fourth quarter of 2018 were three-fold: Disappointing economic growth, underwhelming earnings results and confusion regarding the outlook for future Fed policy. While there has been improvement on two of those three fronts, none have been fully resolved. And, there are still legitimate concerns about the pace of economic growth globally following the disappointing economic readings of the last three months.

Additionally, while it is largely expected that the U.S. and China will sign a new trade deal that will result in tariff reduction, as of this writing, that has not occurred. And as the past two years have taught us, this administration’s approach is an unorthodox one and anything can happen.

Looking forward to the second quarter, we will be searching for signs that global economic growth has stabilized and inflected higher. Additionally, we’ll seek out further clarity on the Fed’s plans for interest rates. Meanwhile, this upcoming earnings season, which begins in two weeks, will also be important as corporate earnings results and commentary need to reinforce and confirm the optimistic economic and corporate views currently reflected in the stock market. Finally, regarding trade, we’ll review and analyze any trade deal to see if it is the economic positive investors believe it will be.

So, we start this second quarter of 2019 thankful for the strong start to the year, but also mindful that now is not a time to become complacent – because risks to investors’ portfolios remain.

Tax season is wrapping up and we just wanted to remind you all to help us help you by bringing your 2018 tax returns in when we have our next meeting. Also a reminder that 2019 contributions to all retirement accounts – IRAs, ROTHs, 401K plans – have increased so be sure to adjust your automatic contributions accordingly!

March Market Update

In Like a Lion, Out like a Lamb!

Well friends, it’s March, the month that supposedly comes “In Like A Lion, Out Like A Lamb.” I think for our clients in Arizona, February turned out to be a Lion-like month, as they have received twice as much rain as normal and had one of the largest snow storms on record. The mountains surrounding the Phoenix area have been covered with snow and Flagstaff received over 3 ft of snow in one day as seen in this picture!

You could say that the markets this year have started out with a ROAR! A change in tone by the Federal Reserve, a decent start to earnings season, and optimism of a US-China Trade deal has sparked a stunning reversal in investor sentiment and ignited a sharp rally to begin the new year. The S&P 500 has gained over 11% so far this year, with 3% of that coming in the month of February.

The Fed

Following its hawkish stance at the December meeting of the Federal Open Market Committee (FOMC), the Fed was clearly taken aback by the sharp drop in stock prices and the concurrent widening of credit spreads and decrease in inflation expectations. And just like that, the Fed pivoted to a more dovish stance at its January FOMC meeting. Instead of promising to raise rates 3 or 4 more times by the end of 2020, plus leaving its balance-sheet reduction plans on autopilot, the Fed all of a sudden is likely on hold for probably the next 6 months, if not longer, and now Chairman Powell has declared the balance reduction will end in 2019. This is an important reminder of the old market mantra: "Don't fight the Fed."

Q4 Earnings

While the Q4 earning season is winding down, with nearly 85% of companies having already reported, the earnings season has been decent with 67% of S&P 500 companies beating earnings per share (EPS). Estimates for Q4 had come down significantly ahead of the start of the season, and with a relatively low number of companies beating their estimates, this does indicate some slowing in earnings growth. Valuations came way down in 2018 which left the market in a much better place in terms of valuation. However, with the S&P 500 recovering while earnings growth is slowing, valuations are by definition getting less compelling again. They’re not too high by any means but they’re no longer a bargain either.

US-China Trade

President Trump announced that he will delay the increase in tariff rates on $200 billion in imports from China scheduled to take effect March 2nd. We expect a short extension in the deadline of 1-2 months. The delay of the deadline was generally expected by financial markets. That said, the ongoing negotiations on specific commitments on six issues (intellectual property, technology transfer, services market access, agriculture, currency, and non-tariff barriers) have raised expectations that a formal agreement could be reached in the next few weeks. Overall, the talks appear to be making some progress. It’s likely that some recently-imposed US tariffs on imports from China will remain in place into 2020 even if the two leaders reach a formal agreement when they meet in Florida in March. While its possible some tariffs could be removed more quickly as part of such a deal, we anticipate that some tariffs imposed last year to remain in place as an enforcement mechanism until certain commitments have been met.

What’s Next?

Although most of our indicators are positive, we wouldn’t be surprised to see the market retrace a little or even chop sideways for a while as it tries to digest what’s next. The rate at which the market has risen is certainly unsustainable for the long run. Two considerations that are on our mind:

First, how much is a US-China trade deal already priced in to the market? (If Boeing stock is any indicator, you might say it’s already priced in – up 37% YTD and the largest component of the DOW)

Second, how much is the balance sheet reduction in 2019 built into stock prices?

If those two factors are priced in, what’s going to carry the S&P 500 higher? Here are some possible candidates: Better Chinese/US global growth, better earnings expectations, a very good US-China trade deal, or a more-dovish-than-expected Fed (i.e. balance sheet reduction ends in a few months). However, it’ll take a bit of time for those events to present themselves, so in the near term we’ve got a market lacking a near-term catalyst, and as such, consolidation around current levels is likely over the next several weeks barring a positive, or negative, surprise on one of the above topics.

Longer term (beyond the next quarter or two) the jury is still very much “out” on global and US growth, as the yield curve and bonds continue to send worrisome signals, so we favor being cautious at the moment as the market likely won’t be so lamb-like the rest of the year.

As we reiterated in our last newsletter, if the latest market volatility caused some sleepless nights, let’s take this recent rally to rebalance your portfolio to a risk level that’s more appropriate.

February Market Update

From one of the most volatile quarters in the market’s history to one of the best January starts for the markets in history … it appears we are in a history-making time! The factors driving one were responsible for the other and it’s an old refrain: China trade talks, Federal Reserve and interest rates, and of course corporate earnings.

Markets bounced strongly off of the lows from the last quarter, despite earnings season kicking off in sour fashion after Apple’s forward guidance disappointed. The recovery was due in part to a bit of market exhaustion – nothing goes down forever, even though it feels like it sometimes! Mostly the bounce can be attributed to the press conference held by Chairman Powell of the Federal Reserve, following their first meeting of the year. At their December meeting, Chairman Powell indicated very little reason to diverge from the path they had been on all year of raising interest rates, and his tone gave little concern to a slowing economy. It was from that point that December turned brutal.

Six weeks and a few news cycles later, his tone was decidedly more conciliatory as he once again addressed the financial press and appeared to not only walk back his December comments, but indicate that the Federal Reserve would be “patient” with any further increases in interest rates. Some have taken this to mean no further rate increases this year, which we think unlikely, but it is helpful for stocks and bonds alike that we do appear to be taking a breath. This has fueled stock market gains and allowed for the strong showing in January.

More importantly for our bond portfolios, we have re-entered high yield bonds in a big way after staying out for most of last year. If the Feds can stay out of our pockets for awhile and oil prices stabilize or improve (the high yield market has a strong correlation to oil prices), we can enjoy the 6% and 7% yields we haven’t seen for a few years! This allows us to temper the volatility to the stock portion of your portfolios as well. And we do think the volatility will continue.

Talks with China on changes to our trade agreements are ongoing, as they have been for almost a year now. We will spend more time on the whole question of the trade agreements for March, but it’s clear that every semblance of progress fuels good days in the market, and every headline of delays does just the opposite. Volatility.

And then there is the political news cycle. We are seeing the first of many, many hats that will be thrown in the ring and the rhetoric will only rise in volume as the year goes on and we get closer to Election Year. Toss in a wall and a second potential government shut down, not to mention the economic damage done by the first one, and political issues could be the biggest factor contributing to volatility in 2019.

‘If you are worried when the stock market goes down and happy when it goes up, it probably indicates that your portfolio is unbalanced. If your income is also tied to how the economy does, you are doubly at risk because your portfolio can go down when your income is worst, which is scary.’

- Ray Dalio (very successful hedge fund manager)

Ray’s words echo our own as we meet with you this year to gauge your temperature for the recent volatility and discuss ways to make sure your investments and tolerance for risk find balance in your financial plan.

Balance means having fun, too, and we still have a few tickets left for the spring training game on Tuesday, February 26th! It’s the Cubs vs. the Diamondbacks at Cubby Stadium, so if you’ve been thinking about a day in the sun with a hotdog, we would love to have you join us. Call the office to reserve your tickets and hope we see you there -

January Market Update

A decade of consecutive positive annual returns from the S&P 500 ended in 2018. In the final three months of the year, the S&P 500 registered its worst quarterly performance in seven years and ended 2018 with a negative annual total return for the first time since 2008.

The break down in stocks was driven by a trifecta of classic economic and market concerns emanating from underwhelming corporate earnings guidance, suddenly lackluster economic growth and disappointment towards Federal Reserve monetary policy.

Stocks initially dropped in early October as the third-quarter corporate earnings season disappointed markets. While most companies beat consensus estimates, as they often do, profit warnings from select multinational and industrial firms such as PPG Industries (PPG) and FedEx (FDX) highlighted growing concerns from analysts about peak earnings growth for U.S. corporations. That rising concern was reflected by the market’s performance during the heart of the third-quarter reporting season, as the S&P 500 declined 6.84% in October.

After a respite from selling in November that saw stocks bounce back slightly from the October losses, earnings concerns were compounded in December by suddenly disappointing economic readings. In early December, multiple economic indicators including manufacturing surveys and the November jobs report missed Wall Street consensus estimates, adding the potential of slowing economic growth to the list of headwinds on stocks.

Finally, uncertainty regarding U.S. monetary policy in the wake of the December rate hike by the Federal Reserve added yet another source of concern for investors, and that additional unknown caused a massive spike in market volatility in late December. Specifically, the Fed increased interest rates for the fourth time in 2018, despite the declines in stocks and wavering economic data, and signaled it expects to increase rates two more times in 2019. That policy decision, which was more restrictive than investors were hoping for, caused stocks to plunge as the major equity indexes dropped to fresh 52-week lows during the final two weeks of December. Markets did bounce modestly during the final days of 2018 to finish off the worst levels of the year, but still solidly negative on an annual basis.

While broad US markets were all down for the year, commodities such as oil and gold, suffered greater losses due in part to the continued strength of the dollar for most of the year. A similar fate was suffered by international markets which saw yearly declines of more than 13% for developed international markets and over 14% for emerging markets.

Despite the legitimate concerns about economic growth, earnings and Fed policy, the news in the fourth quarter wasn’t all bad.

First, the U.S. and China agreed to a temporary trade war “truce” and began an intense, 90-day negotiation period aimed at ending the trade war.

Second, the European Union and the Italian government reached a compromise on Italy’s proposed 2019 budget that satisfied European Commission rules, thereby avoiding a political showdown.

Lastly, most major indicators of U.S. economic growth, while exhibiting a loss of momentum, remained in solidly positive territory, meaning the economy is still growing (albeit, potentially at a slower pace). The November Employment Situation Report showed positive jobs growth and an unemployment rate under 4% while regional manufacturing surveys remained in positive territory.

In sum, 2018 was a very difficult year in the markets and for investors. Not only did most major stock indices post a negative full-year total return for the first time since 2008, but the declines came with two episodes of intense, confidence-shaking volatility in the first and fourth quarters. That being said, 2018 was not 2008; this is the perfect time to reflect on risk tolerance and adjust your portfolio accordingly if you found this volatility kept you from sleeping well.

So what are our expectations for 2019?

At a minimum, we can expect continued volatility in stock, bond and commodity markets in the coming months. And, whether the markets continue the fourth-quarter declines or rebound will depend largely on the resolution of those three uncertainties facing markets: Earnings, economic growth and Fed policy.

Regarding earnings, the bulk of the fourth-quarter 2018 earnings results will be released this month, so within the next few weeks we should learn whether U.S. corporate results have stabilized, or whether the disappointing guidance we saw from companies in Q3 continued. Apple certainly did not help the volatility picture, when kicking off earnings season with less than stellar results this week and, most importantly, downgrading their future expectations, citing concerns about the trade tariffs. Yet we have quickly followed a horrible day with a huge positive given the great employment report. Such is the stuff of volatility.

We understand the risks facing both the markets and the economy, and we are committed to helping you effectively navigate this challenging investment environment. In your portfolios here, we had several risk-off triggers hit during the prior quarter and given the continued volatility, have not seen the stability we need to see to return to those positions. A measured approach will likely be the solution for this year as we continue to work with you to ensure your investments are in line with the needs of your financial plan.

Welcome to a new year!