Monthly Markets Memo - March 2019
by Dan Zalipski, CFA
Over the past month the equity markets continue to grind higher. Investors are optimistic that the U.S. may be nearing a trade deal with China. President Trump had pushed back the March 1st deadline to raise existing tariffs on Chinese goods to 25%, a sign that progress is being made on negotiations. This is further supported by National Economic Council Director Larry Kudlow stating that negotiators have made ‘great headway’ working on a deal. Even so, concerns remain as mixed messages continue to trickle out, with the President recently stating that he is in no rush and would even walk away from a potential deal that fails to address key issues, such as intellectual property and technology transfers. Two steps forward, one step back.
While equities grind higher, bond yields have been moving lower. This is somewhat perplexing as it seems to contradict the optimism in the equity markets. Lower yields can signal slowing economic growth and an increased aversion to risk, neither are generally supportive of equities. This is not always the case, however, and there are some explanations that do not involve gloomy economic forecasts. Yields may be moving lower as they price in a newly patient Federal Reserve that recently paused any additional interest rate increases. The relative yield between U.S. and foreign sovereign bonds could also be playing a role. In general, foreign yields are significantly lower than what can be obtained in U.S. markets, driving demand for U.S. Treasuries. Higher demand can act as an anchor on yields. The move in yields would be more concerning if we saw negative activity in corporate and high yield bond markets, neither of which are flashing imminent warning signs.
Fourth quarter earnings season is nearly over. With a majority of the companies reporting, S&P 500 earnings growth for the quarter was 13.4%, marking the fifth straight quarter of double-digit growth. Nearly 70% of companies exceeded their earnings estimates. Unfortunately, nearly the same percentage have issued negative earnings guidance. As we look forward to 2019’s first quarter earnings, companies are expecting to see earnings decline in the face of a strong U.S. dollar, slowing global growth, and trade tensions. The estimated earnings decline in Q1 2019 for the S&P 500 is -3.4%. This number is even lower for companies that generate most of their revenue outside the U.S., further highlighting the potential impacts of a global slowdown. Despite the negative estimates for Q1 analysts are expecting positive growth for the remainder of 2019, but only in the mid-single digits, leaving little cushion for the unexpected.
For now, the U.S. remains the best house on the block. Unemployment and inflation remain low while wages are rising. The February jobs report was shockingly low with just 20,000 new jobs added. It’s important to note that the previous two reports for December and January were higher than expected with 227,000 and 311,000 new jobs. When viewed through a wider lens, the average 3-month job gain remains at 186,000 per month, right in line with expectations. GDP growth is expected to slow in the U.S. but remain positive. We are late-cycle, but not yet end-of-cycle and continue to believe recessionary fears are premature. We remain focused and invested for the long-term.
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