First Quarter Market Review
Unlike the Lexus car commercial with the slogan, “A December to Remember”, the fourth quarter of 2018 was one we would all like to forget. The first quarter went a long way in helping that effort, as U.S. equities experienced the largest quarterly gain since 2009. The S&P 500 rose 13.6% during the quarter, a marked improvement from the prior quarter. To put this gain into perspective, over the past 25 years (1994-2018), the average first quarter increase for the S&P has been 1.7%. Suffice it to say, this was an excellent quarter for U.S. stocks.
Large cap stocks were not the only bright spot; small cap U.S. stocks were also one of the best performing asset classes, rebounding from their December lows, and generating their best quarter since 1991. Real Estate Investment Trusts also outperformed most major asset classes. Overseas investments also did well, as global equities rose 12%, while developed international and emerging market equities rose almost 10% respectively. Notably, commodities were led by West Texas Intermediate (WTI) oil prices, which increased nearly 32.5% to over $60 per barrel, its biggest increase in almost 10 years, largely due to reduced supply from OPEC countries and U.S. sanctions on Iran and Venezuela.
Despite no resolution being found regarding the United Kingdom leaving the European Union, developed international equities bucked the negative BREXIT headlines. As the original March 29 exit deadline came and passed, little progress was made on the future of Article 50, which remains a fluid situation. Parliament in the United Kingdom held votes on eight options, but none received the majority approval needed for a formal vote. Prime Minister Theresa May’s plans for withdrawing from the EU were voted down three times with the most recent result extending the deadline of a deal until October 31st.
So what were the main drivers behind this quarter’s equity markets? Several factors were at play, the largest being the Federal Reserve’s dovish comments surrounding future rate hikes. Fed Chair Powell stated they would be “patient” given inflation data seems relatively benign. Powell also stated a willingness to adjust the Fed’s balance sheet normalization efforts if necessary. Additionally, despite no real resolution, expectations for a U.S.-China trade deal provided a nice tailwind as the uncertainty surrounding global trade faded.
Treasuries rallied during the quarter, as the yield on 10-year notes fell over 25 basis points (0.25%), to around 2.40%. Fears of being over 10 years into an economic expansion and slowing global growth were reflected in the continued flattening of the yield curve, with the spread between 3-month and 10-year debt inverting for the first time since 2007.
So where does that leave us for the remainder of the year? Madison constructs globally-diversified portfolios with the aim of weathering any market environment regardless of what happens in the next quarter or even year. We take few liberties in trying to time our behaviors in advance of market moves, nor do we attempt to forecast the future with any degree of certainty. As evidenced by Chairman Powell’s reversal in monetary policy talk, forecasting is incredibly hard, even for the most informed people. Markets always have something to worry about, yet have found a way to go higher over the long term.
More recently, this worry has been around slowing global growth, yield curve inversion, and fears of what “being late in the cycle” can mean for investors. As it relates to yield curve inversion, several high-level bank CEO’s have uttered the famous line that “this time is different”, as artificially low interest rates have reduced the signaling power of a yield curve inversion, especially given credit spreads have not widened materially. Time will tell if bank lending and liquidity dries up given the quick inversion. However, we would note that market analysts from Bespoke Investment Group have stated that in the prior four yield curve inversions where 3-month debt has yielded more than 10-year debt, in the year after inversion, the S&P 500 was positive every time with a gain of at least 9%, and rallies lasted 12 to 24 months on average.
How long this cycle can last is anyone’s guess, but corporate balance sheets appear to be in relatively good shape with companies generating solid profits and cash flows. In fact, in the fourth quarter of 2018, companies in the S&P 500 spent a record $223 billion on stock buybacks, and for the full year spent $806 billion on stock buybacks, breaking the old record for share buybacks of $589 billion set in 2007. Although earnings revisions have trended south, we think this was inevitable given the tax-cut-fueled earnings boost. Trade and tariff resolution and earnings that meet a relatively low bar could be positives on the upside.
Finally, we wish to take a minute to thank each and every one of our clients and friends for the trust and confidence you place in us. We come to work everyday with passion for our vocation to help make your dreams a reality. We take this responsibility very seriously. To further these efforts, we continue to add to our professional and service teams to provide our clients with thoughtful advice and the high touch service you’ve come to know and expect. We hope you will consider recommending us to like-minded family and friends who could benefit from Madison’s holistic approach to wealth management.