Stocks were off to their best two-month start to a year in roughly three decades, with the S&P 500 rising nearly 11.5% from January 1 thru February 28. The US Federal Reserve’s easier stance and progress in US / China trade negotiations were two factors helping to drive demand for stocks.
While the pace of gains slowed in equities as February drew to a close, returns were positive across equity markets for the month. Small company stocks fared the best, rising more than 5%. Gains for large company stocks were more modest, at around 3%, and Emerging Markets equities were slightly in the black.
In line with the broad-based rally in risky assets, lower-quality bonds did best in February, with High Yield returning 1.7%. Corporate bonds posted slight gains, and commodities indexes continued to move higher, helped by the rise in oil. Treasury bonds, which are the most sensitive to interest rate movements, posted slight losses as rates increased a bit in February.
Fed. The likelihood of an interest rate increase by the Fed in the near term now seems quite low. The Fed’s major shift in tone occurred in January, and was supported by comments made by Fed Chair Powell when he testified to Congress in February. The equity markets have breathed a collective sigh of relief. The change in the Fed’s tone, and expectations that any interest rate increases in the medium term will be modest, has been a main factor for the rally in equities since the start of 2019.
International Developments. The US and China seem close to a deal on trade. Importantly, both sides have been meeting, negotiations are moving forward, and the US chose not to implement a tariff increase that was scheduled for March 1. Progress toward a resolution for the US / China trade dispute has been the other main factor for the move up in stock prices so far this year.
U.S. Economy. U.S. GDP growth came in at 3.1% in 2018. Strong employment gains have been an important factor in supporting consumer spending and economic growth. Forecasters are generally expecting the pace of growth to moderate in 2019 but to remain positive. The consensus view by economists for 1Q19 growth (annualized) is now currently right around 2%.
Earnings. Corporate profitability ran at an unusually high rate in 2018 (growing above 20% for the first three quarters of last year), helped by a favorable tax environment. This pace of growth will not be sustained. Analysts currently expect no earnings growth in the current quarter for S&P 500 companies in aggregate. At this point, the earnings slowdown doesn’t have to be a cause for worry. Gradual improvement in US corporate profitability is anticipated as we move through 2019.
Closing Thoughts. Price swings in both the stock and bond markets have been much less pronounced this year than in the last quarter of 2018. There were only two days when the S&P 500 index declined more than 1% in January, and none in February, compared to 8 days of 1.5% or greater declines in December 2018. While calmer markets go a long way in reducing investors’ anxiety, we caution against complacency. We think the best way to handle the market’s ups and downs is by staying invested in a broadly diversified portfolio.
Rob Kania is a Principal and Co-founder of Laurentide Advisory
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