Stocks Hold Strong as Economy Slows

Stocks Robust Around the World

In the first quarter of 2019, U.S. stocks surged to their best quarterly returns since 2009.  As is often the case with markets, the sharp gains came from a rebound following a vertiginous drop in the recent past.  The S&P 500 Index rose 13% in the quarter and all eleven S&P economic sectors registered gains, demonstrating the breadth of the rally.  Overseas, stocks posted nice gains as well.  Europe (Stoxx Europe 600) was up around 12% and China (Shanghai Composite) rocketed 24%.  The Dow Jones Global Dow (ex-U.S.) was up nearly 10%.

Economic Data Looking Weaker

The strong performance in global equity markets comes in the face of weakening economic data both in the U.S and in most international markets.  The Federal Reserve recently lowered its economic growth projection for 2019 from the 2.3% GDP growth it was expecting at the beginning of the year to 2.1% growth for the balance of 2019.  The Fed also suggested it had no plan to raise interest rates in 2019.

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Last week, the International Monetary Fund (IMF) also reduced its global economic growth outlook to a gain of just 3.3% from the previous figure of 3.5%.  Should the 3.3% forecast prove accurate, 2019 would tie 2016 for the lowest rate of global growth in the last decade.  Europe, already suffering from Brexit fears, is already quite weak while Asia, hurt by trade uncertainties, is also slowing.

Earnings Likely to Decline Modestly

U.S. corporations have begun to report their first quarter financial results.  Because the new tax laws came into effect in the first quarter of 2018, this quarter will be the first one in a year that will have similar tax impacts as the prior-year quarter.  While the corporate tax cuts turbo-charged corporate profit growth for the last four quarters, this tax effect will no longer provide a tailwind for reported earnings growth.  Analysts are broadly expecting U.S. corporate profits to decline by around 4% in the first quarter and then by about half a percent in the June quarter.  Investors seem unperturbed by the dimming profit outlook, however, and have pushed the S&P 500 Index to within a whisker of the all-time highs it reached in September 2018.

Investors Hoping for Goldilocks Scenario

With markets having done well lately and with economic data beginning to weaken, investors appear to be anticipating a Goldilocks scenario.  For the balance of 2019, they seem to expect a situation in which growth is not so hot as to compel the Fed to get back in the rate-hiking game, but also not so slow that it hurts corporate earnings unduly.  Since November, the interest rate on the 10-year U.S. Treasury note has declined from 3.23% to 2.6% today.  This is a very large move down and is indicative of how much investor attitudes have shifted over recent months from fearing Fed rate hikes amid strong growth to now being more concerned about a potential economic downturn.

China News Should be Coming Soon

The primary near-term wild card for global markets is the China trade negotiation.  As constructive news on the talks is occasionally dribbled out, investors seem to be increasingly convinced that some sort of deal is at hand. If this is indeed the case, markets (in my estimation) are probably unlikely to react much if a deal is sealed. However, they will likely react negatively to a collapse of talks or a long delay.

 

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Peter Thoms

About the author

Peter Thoms, CFA, founded Orion Capital Management LLC in April 2002. Peter has an extensive background in crafting investment solutions for high-income clients in a wide variety of circumstances.