It should be news to no one at this point that 2019 is off to a fantastic start – at least for investors who continued to “stand in the pocket” despite getting repeatedly knocked down during 4Q’18. As many market participants believed at the time, the reaction by the financial markets to perceived slowing of economic growth that was anticipated (and is playing out) during the 1Q was overdone. But in fairness to investors, perceived Government missteps (or perhaps more fairly described as inflexibility) both on monetary policy evolution (Fed tightening) and Trade (US-China) made it hard to maintain confidence in officials being able to do the right thing for the US economy in the face of persistent international economic weakness and uncertainty. Since that time, sentiment on both items has turned more favorable, leading to a swift recovery for domestic equities. Investors also find themselves questioning whether they have been too pessimistic over international economic and financial market prospects. Significant economic, regulatory, and political uncertainties hampered international investing success for much of this 10-year cycle, but lesser acknowledged is how much has been done to improve monetary policy transmission in support of the banking system and economic growth. This sets international markets for potential out-performance especially when considering valuations overseas are more attractive than domestic on a number of measures and the currencies are cheap relative to USD.
From an economic perspective, data both domestic and international are supporting the idea that an economic soft-landing can be achieved rather than an abrupt slowdown or outright recession. In China, the world’s 2nd largest economic power, real GDP was +6.4% y/y in 1Q and significant stimulus is being pursued. Trade discussion is also more constructive between the US and China than throughout 2018. Home prices, investment, industrial production, and retail sales all showed signs of forming a bottom. Interesting to contemplate the degree to which Chinese data can be trusted as trade negotiations mature as China arguably wants to portray strength for bargaining power, but for now investors are inclined to operate on the presumption that stimulative efforts are working – especially when global commodities such as copper, iron ore, and oil are all implying a pickup in economic activity via their firming prices. Domestically, industrial production was soft and housing starts dipped in March. But retail sales surprised to the upside and consumer confidence is rising with weekly unemployment claims near the lowest levels since the 1960s. But all of this suggests that while the Fed is again data-dependent and more patient before pursuing any additional rate hikes, it would at the same time appear wholly inappropriate for the Fed to cut rates as some market participants (and bond markets seem to be conveying) presently expect later this year. At the moment, leading indicators appearing better than coincident data suggests that someone (bond investors and their view on interest rates vs. equity investors and their views on growth/inflation) will be incorrect.
With 1Q earnings season now underway, the month of April is expanding the YTD strength. Interestingly, some more cyclical corners of the market are again leading the pack. Month-to-date international equities are as a group also running faster. With the US digging out of its soft patch and China re-accelerating, other players around the world including Europe and Japan also stand to benefit. This is important because it would imply a return to more synchronized global activity is in the making; periods of such tend to be a tailwind for investors. But when also considering that US employment appears with little slack, the threat of faster wage growth is not dead. As noted above, the market may want and be thinking it will get Fed rate cuts still in 2019 (as evidenced by the bid bonds have received), the market may or should not get rate cuts if leading cyclical data is turning higher. Something will need to give. Corporate earnings season is upon us as is the often discussed dreaded month of May. For the time being, the financial markets appear surprisingly calm but we would not be surprised if that were to change relatively quickly! We do remain of the perspective that the result between here and the balance of the year is rewarding, even if the path is not without bumps.