1st Quarter 2019 Commentary

Leonard Rickey Investment Advisors

Market Summary

After one of the worst quarters in a decade, stocks shrugged off many of the uncertainties surrounding interest rates, trade wars and slowing global growth to have one of the best quarters in a decade. U.S. stocks, as measured by the S&P 500 TR Index, were up 13.6% for the quarter. This was almost the exact mirror image of the previous quarter, when the S&P 500 TR was down 13.5%. It also marked the strongest quarterly return since September 2009 and the best first quarter since 1998[1]. The hardest-hit segments of the market during the fourth quarter were the largest rebounders, with small-cap and growth stocks leading the rally.

In the face of worsening economic data, the Federal Reserve (Fed) indicated there will be no further rate hikes in 2019. This was a significant deviation from December 2018 when the Fed estimated an additional two hikes for 2019. This change was welcome news for risk assets as the quarter produced strong returns for nearly all asset classes.  More accommodative monetary policy in Europe and China also helped to boost markets overseas as central bankers around the world acknowledged the impact of slowing global economic growth.

U.S. stocks outperformed both Emerging and Developed International stocks. Fixed income assets posted positive returns across the board, with higher-risk areas such as high-yield corporate credit and emerging-market debt leading the way. Commodities were also up strongly as oil had its best quarter in almost a decade. Overall, the first quarter was one of the strongest starts to the year we’ve had in a very long time. Below is a summary of returns for the major asset classes[2].

 

Equity Markets

The Fed’s dovish turn and growing hopes for a U.S.‑China trade deal moderated two of the primary sources of uncertainty that hurt stock prices late in 2018. All 11 market sectors produced positive returns for the quarter. The strongest performers came from economically sensitive sectors:  Technology (up 19.6%), Industrials (up 17.7%), and Communication Services (up 16.7%) sectors led the way. Defensive sectors lagged in the quarter as healthcare stocks performed the worst (see chart below)[4].

U.S. corporate earnings growth remained strong but decelerated during the quarter as the impact of the 2017 tax cuts rolled off and fiscal stimulus faded. Non-US developed- and emerging-market profit growth, however, moved into negative territory during the quarter. Forward estimates pointed to market expectations for earnings growth in the mid-single-digit range over the next 12 months[5].

March marked the 10th anniversary of the bull market. Over the last 10 years, the S&P 500 TR Index was up over 15% annualized while non-U.S. stock (both Developed and Emerging Markets ) returned just shy of 9% annualized[6]. Within the U.S., the outperformance of Growth stocks has been a dominate theme this cycle, particularly over the last five years. Growth stocks (as measured by the Morningstar US Large Growth Index) have outperformed Value stocks (as measured by the Morningstar US Large Value Index) by around 6% annualized over the last 1, 3 and 5 years (see graph below)[7].

The economic cycle is different than the stock market cycle. While economic expansion has been slow compared to historical averages[8], U.S. stock market gains have been strong. Rising stock prices combined with rising home prices continued to boost the market value of U.S. assets relative to the output of the U.S. economy. Throughout this expansion, low interest rates have generated neither above trend economic growth nor rising inflation. However, they have persistently boosted asset prices, leaving both U.S. stock and bond valuations at high levels.

In the bond market, the real yield on 3-month T-bills finished far below historical averages and investors were generally not being paid for taking the duration or credit risks required to boost those yields. Similarly, in U.S. stocks, valuation ratios finished above their long-term averages. A long-term threat to the expansion is that asset prices rise too far and then, eventually, fall too fast.

Valuation ratios for international developed and emerging-market equities remained lower than those for the U.S., providing a more favorable long-term valuation backdrop for non-US stocks[9].

 

Bond Market

The most notable news affecting bonds was a change in central bank policy. In a desire to support economic growth, the Fed didn’t increase interest rates for the first time in 10 quarters. The Fed noted that they expect U.S. economic growth to continue amid a strong labor market and moderate inflation, but they didn’t see the economy as strong enough to withstand higher interest rates. At the same time, the European Central Bank lowered growth forecasts and pledged to keep rates low. The bond market responded to these developments by pushing long-term bond yields lower and prices higher. The yield on the 10-year U.S. Treasury note finished the quarter at 2.41%, its lowest level since December 2017[10].

While long-term interest rates fell, short term rates stayed relatively flat causing the yield curve to temporarily invert. This briefly occurred during the quarter when 3-month U.S. Treasury’s yielded more than 10-year U.S. Treasury’s. Some consider this movement a harbinger of recession. While some historical data does support this claim, the yield curve typically flickers between positive and negative several times before the U.S. economy peaks (see graph below)[11]. All in all, the inversion was very small and short-lived, and the attention may have been a little overblown. In our opinion, the inversion is more of a warning signal than all out buy/sell signal.

 

Economic Update

Economic growth remained slow but positive despite some signs of slowing growth. Early in the quarter, economic data was slower than expected due to the U.S.-China trade dispute, tightening monetary conditions and lower consumer and business confidence. Adding to investor’s concerns was the fact that this economic expansion is nearing 10 years in length (currently the second longest on record). This factor, along with signs of slowing growth had many investors nervous as to whether the slowdown pointed to this cycle’s end – perhaps leading to a recession – or merely to a temporary setback.

It appeared as if it was only a temporary setback. As the quarter progressed, economic data came in more favorably and was consistent to a U.S. economy that remained on sound footing. Gross Domestic Product (GDP) slowed from previous quarters but remained positive[12].

In addition, the U.S. consumer spending outlook remained solid, buoyed by continued gains in employment and wages. Jobs reports started the quarter slowly but finished strong. On average, the economy added 186k jobs over the past three months. Wages grew at their fastest pace this cycle and the unemployment rate remained at a historically low figure of 3.8%[13].

Housing and auto sales had been in a downtrend since 2017 but both segments rebounded sharply during the quarter. The decrease in interest rates was likely a factor for the rebound, but increased wages may also have been an influence. After increasing in 2017 and 2018, mortgage rates fell significantly last quarter, spurring more demand for houses. National average rates finished near 4%[14].

In addition, national home prices continued to increase, as the Case Shiller National Home Price Index gained 4.3% year over year[15]. Home prices have increased every year since 2013.

 

As always, please call if you have any questions or would like to discuss your account in more detail.

 

 

 

[1] Data from Morningstar

[2] Through March 31, 2019. All Returns in U.S. dollars. Data from Morningstar.

[3] Alternatives benchmark includes 50% SG Trend Index, 25% Swiss Re Global Cat Bond TR Index and 25% CBOE Eurekahedge Short Volatility Hedge Fund Index

[4] Morningstar

[5] Factset

[6] Data from Morningstar

[7] Morningstar

[8] Average Real GDP growth of 2.7% compared to 2.3% during this cycle. Source: JPMorgan

[9] Source: StarCapital. The presented valuation ratios are market-capitalization-weighted. “Weight” provides the actual country weight. PE (Price-Earnings-Ratio), PC (Price-Cashflow-Ratio), PS (Price-Sales-Ratio) and DY (Dividend-Yield) are based on trailing 12 month values. PB (Price-Book-Ratio) is based on the most recent company financial statements.

[10] Treasury.gov

[11] LPL Research. Inversion refers to the 10-year Treasury yield below the 3-month Treasury yield

[12] Baird Quarterly Market Insights

[13] JPMorgan Guide to the Markets

[14] Federal Reserve Economic Data

[15] Federal Reserve Economic Data

 

 

 

IMPORTANT DISCLOSURES

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced herein is historical in nature and is not an indication of or a guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any particular strategy or investment will prove profitable.   As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. This newsletter should not be regarded as a complete analysis of the subjects discussed. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy. The fast price swings in commodities and currencies can result in significant volatility in an investor’s holdings. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors. For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.

INDEX DEFINITIONS

The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It cannot be invested into directly.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices of approximately 800 stocks and is designed to measure equity market performance in 23 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, , Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.

The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index of approximately 900 stocks and is designed to measure equity market performance in 21 developed market countries outside of North America.

Morningstar US Large Growth Index measures the performance of large-cap stocks that are expected to grow at a faster pace than the rest of the market as measured by forward earnings, historical earnings, book value, cash flow and sales.

Morningstar US Large Value Index measures the performance of large-cap stocks with relatively low prices given anticipated per-share earnings, book value, cash flow, sales and dividends.