11 Apr Q1 2019 Market Commentary
Director of Investments Todd Jones, MBA, CAIA®, weighs in on the current financial environment and critical market trends.
Here’s what Todd is talking about this quarter:
Performance of global equity markets in the first quarter reversed almost all of the damage done in the fourth quarter of 2018.
Now that we’ve experienced a +13% move up in equity prices in Q1, we believe that equity markets will likely be range-bound for some time.
Prospects for bonds continue to look attractive as global growth remains low.
New opportunities are arising in areas we haven’t had exposure to in many years.
Q1 2019 Reversal
Performance of global equity markets in the first quarter reversed almost all of the damage done in the fourth quarter of 2018. As you will note in the chart below, it’s as if the fourth quarter never happened when looking at the S&P 500 (red) while emerging markets have exhibited stronger performance (blue) due to a shallower draw-down. Developed international markets continue to exhibit weaker relative performance, which is likely attributable to both (1) weaker currencies relative to the US Dollar and (2) softer economic growth.
Where Do We Go From Here?
The question, therefore, is now that we’re back to the prior high-water mark, where do we go from here? As we indicated in our 4th Quarter Market Outlook (click here), the balance of probabilities suggested that global equity markets looked attractive and that new positions could be added. Now that we’ve experienced a +13% move up in equity prices in Q1, we believe that equity markets will likely be range-bound for some time for the following reasons:
Valuation expansion has been the primary reason for the move higher in equities during Q1. Further expansion in valuation seems unlikely.
Subdued inflation provides valuation support at current levels.
Stable growth across all developed markets (US, Europe, Japan) helps remove significant downside scenarios, from an economic standpoint.
Institutional investor sentiment remains negative and is largely already expressed in equity prices.
In all, sideways movements in equity markets aren’t an entirely bad situation. What might be considered frustrating for an index investor is actually a welcome opportunity for more active investors, especially those who manage individual securities or active mutual fund strategies.
Turning to the bond market, prospects for bonds continue to look attractive as global growth remains low. Further, global central banks have been unwilling to push for a normalization in interest rates at such low growth rates, fearing that rate normalization may end up causing the next recession.
This fear isn’t isolated to just the US Federal Reserve – it also applies to most global central banks. After raising the US Federal Funds rate from 0.25% to the current range of 2.25-2.50%, the US Federal Reserve has now pivoted from its previous “autopilot” to a “wait-and-see” approach.
Interestingly, over the last 35 years, whenever the US Federal Reserve has moved to a “wait-and-see” approach (1989, 1995, 2000, and 2006), interest rates have moved lower in every period. This dynamic has important investment implications in that we should expect more upside in price from our bond strategies, especially if the US Federal Reserve starts cutting the Fed Funds rate.
That said, understanding where we are in the economic/credit cycle can lead to valuable portfolio positioning adjustments.
US Treasury Yield Curve
The primary reason to monitor the yield curve is because the shape of the yield curve has an accurate track record of signaling a recession. The yield curve sends a recessionary signal when it becomes inverted (meaning short-term yields are higher than long-term). In April 2019, only part of the yield curve is inverted. Consequently, the signal from the bond market remains inconclusive.
Finally, while we are relatively positive on the prospect for bonds and neutral on equities, new opportunities are arising in areas we haven’t had exposure to in many years. An example is found in commodities in our growth-oriented alternative strategies. We’ve avoided a commodity strategy primarily because we could not forecast how global interest rate suppression (via central bank activity) would impact the prospects for commodities. Thus, our decision was to avoid commodities entirely.
Why Look at Commodities Now?
There are many reasons to own commodities at this juncture, in our estimation. One has to do with the relative performance of stocks versus commodities. The chart below shows the relationship between the S&P 500 and the Jefferies CRB index, as a ratio. Where the chart is going up, the S&P 500 is outperforming commodities. Where the chart is going down, commodities are outperforming the S&P 500.
One conclusion that led to our recent commodities investment is that we believe commodities have a strong likelihood of outperforming stocks in the years to come. We think that the intermediate-term outlook for commodities is positive due to
a rationalized supply situation among a number of different commodity industries,
the US dollar coming off a period of sustained out-performance relative to most every other currency and appearing likely to give back some of those gains, and
the possibility of longer-term inflation developing if central banks’ quantitative easing programs work as designed.
Pulling it all together, we remain fairly conservative in our portfolios. Valuations in both equities and bonds prevent any aggressive positioning in those segments, while new opportunities in alternative strategies are looking better.
 Yield curve refers to the relationship between the maturity of a fixed income security and its yield. In a “normal” yield curve, shorter-term securities yield less than longer-term securities; therefore the yield curve has a positive slope. In an “inverted” yield curve, shorter-term securities yield more than longer-term securities; therefore the yield curve has a negative slope.
Todd Jones, MBA, CAIA®
Gratus Capital is an SEC-registered investment adviser. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request. The opinions expressed are as of April 2019 and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities. Examples provided are based on current market conditions, and there is no guarantee that any applicable condition will remain in place. Portfolio holdings are subject to change at any time and may differ materially in the future from case studies presented. No graph or chart by itself can be used to determine which securities to buy or sell or when to buy or sell them. As with any investments, past performance is not a guarantee of future results. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.