2019 1st Quarter Equity Market Update
Portfolio Strategy - 2019 1st Quarter Equity Market Update
Summary:
Outlook: Following a 19.5% decline that ended on Christmas Eve, the market has followed the path of least resistance higher (with limited volatility) to begin the year (up over 20%+ from the December lows). However, unsurprisingly given the sharp move higher, the market began to stall around the 2800-2815 level as slowing macro, yield curve inversion, and trade (recent takeaways suggest talks may linger into June) dominate headlines. Despite the potential risks facing the market, we believe it is important to take into account the economic backdrop, which generally remains supportive of equities, and not look at only one data point (such as inverted yield curve). While the increased risks may make the market more vulnerable to shocks, we continue to believe the positives outweigh the negatives. Overall, we continue to believe the US economy is generally healthy, albeit there are some areas that are slowing, and earnings, while being revised lower, still point to growth in 2019. Our base case scenario of 2946 (applying 17.75x P/E multiple to $166 in earnings) for year-end 2019 implies 4% upside from current levels, prior to dividends.
Over the quarter, the Fed has shifted to a more dovish stance (kept rates unchanged at the most recent FOMC meeting and now expects zero rate increases in 2019, down from prior expectations of two); global manufacturing growth has slowed; inflation has remained muted; trade talks with China have been constructive (and the 25% tariffs going into effect on $200 billion of goods in early March were delayed), but there has not been a final trade agreement yet; potential to levy tariffs on European autos; concerns around Brexit have increased (although largely overlooked by the market); and the spread between the 10-year and 3-month recently inverted. We believe the inverted yield curve (10-year to 3-month) deserves investors’ attention, given its historical track record of preceding recessions, but given that other spreads (10/2 year and 30 year/3 month) have not inverted and US economic data points have been mixed, we would continue to caution investors from overreacting, as there has historically been a long lead time from the initial inversion until a recession actually begins. Trade remains the biggest wildcard for the market. Despite constructive talks with China and the delay in 25% tariffs going into effect, there has not been a final agreement as there remains several sticking points (IP transfer, trade enforcement rules, etc.). Although our base case assumes that enough progress is made on trade to deliver a positive tone, in the event that trade talks fall apart, this would present a downside shock for the market.
