Q1 Market Report

So far, 2019 has been a good year for the stock market. The S&P 500 index shot up over 14% during the first quarter. Of course, several major indices ended in bear market territory last year. Investment analysts are divided on the direction the markets will head. Many are questioning if the positive market trend will continue.

Q1 S&P 500 returns

As always, that’s impossible to predict. Recent news and analysis tend to show a favorable short-term outlook. The consensus in the industry is that there are increasing odds a recession approaching. Today, I’ll fill you in what’s driving those views.

On the Brightside…

The first quarter of 2019 saw the conclusion of one of the biggest news stories that had been impacting the stock market. That being, of course, the Mueller probe into foreign interference in the 2016 election. From strictly an investment perspective, reaching the end of that investigation can be seen as a positive. We now have a better idea of the trajectory economic policy will head moving forward.

That doesn’t mean we might be surprised to find that direction abruptly changing. In fact, some of the better economic news has come from recent unforeseen changes. One big change that could push up market values is a potential end to the trade war.

When tariffs were announced on China in 2018, the stock market took an immediate turn for the worse. As of a week ago, the President indicated he was comfortable continuing with trade tariffs indefinitely. Today, we’re hearing that a resolution is near.

Another positive story is the President’s sudden in position in regards to shutting down the U.S.- Mexico border. We also had a quick reversal on updating the Affordable Care Act. It may be hard to keep up with the news cycle… but behavior like this is becoming normalized. What this is signaling to investors is that many of the more outlandish proposals are simply political posturing.

Let’s hope that’s the case.

…on the other hand

Some of the policies have already done economic damage. Brexit is one such example. Economists believe that Great Britain leaving the European Union could cause cascading economic losses across the nation, continent and globe. Parliament passed (by one vote) an extension to delay leaving the EU  today, leaving hope that a more grounded decision can be made in the future. No matter the outcome, most investors have already accounted for Brexit. That fact that should help minimize any eventual negative impact.

Brexit, like many of the other recent concerns, is an entirely man-made problem. Another concern among financial professionals is that the yield curve inverted yet again. While this in itself doesn’t cause economic harm, reaction to the news often leads to a recession.

How long until a recession

According to the San Francisco Federal Reserve, the 10y-3m yield curve is the best recession predictor ever discovered. The Cleveland Fed reports that every yield inversion since 1966 every save for one (89% accuracy) has resulted in a recession starting within the next 16 months. That's likely because, according to a survey of banking loan officers by the Dallas Fed, banks use a prolonged moderate inversion of the 10y-3m curve as a sign they need to pull back on lending. This can cause the recession banks feared. In recent months, the flattening yield curve has been pointing to rising recession risk, which on February 22nd hit the highest levels this economic cycle.

Can economic growth continue? Absolutely. Australia hasn’t had a recession in over 27 years… there’s no reason why the U.S. shouldn’t be able to as well. In general, most economic indicators are positive despite the uncertainty ahead. Almost every corporate CFO is confident that there will be no recession in 2019.

We’ve seen a lot of uncertainty get lifted from investors shoulders in the last few weeks. Unfortunately, the odds of a recession recently spiked at a three-year high. The most important take away should be that today’s noise shouldn’t have an impact on working towards your long-term goals.

For longer term goals, we’ll want to take advantage of the fact that the stock market (S&P 500 1926 – 2018) has historically provided an 10% average annual return. Longer-term investors should continue to focus on maintaining a balanced, global oriented investment allocation that focuses on equities. This doesn’t mean ignoring current events. Times like these still warrant a restrained approach towards investment selection.

That being said, if you’re a longer-term investor and the market declines, the best path forward would be to maximize the amount of savings into the market. An investment of $10,000 into the S&P 500 Index at the bottom of the Great Recession (March 9th, 2009) would have grown to $42,638.80 today! Of course, don’t try to predict the bottom of the market. Instead, make sure that you’re putting money into your investments on a regular basis.

Shorter term investors should be exercising even more caution, however. Typically, as you approach retirement, there should be a gradual drawdown in equities that leaves your investment portfolio concentrated in fixed income investments. Given the low interest rate environment, bonds have provided fairly low yields over the last decade. This has pushed some investors towards more aggressive investments.

About half of baby boomers are currently overinvested in stocks right now, setting the stage for economic pain and delayed retirement. While I’ve gone over the possibility of continued economic expansion, there is no way that I’d recommend someone within five years of retirement continue to hold an aggressive retirement portfolio given the current economic climate.

An old adage among economists is that expansions don’t die of old age, something has to happen to cause them. What could cause the next recession is anyone’s guess… but it will most certainly be a problem of our own design. Without risk, there would be no rewards. That’s just the nature of investing.

If you think a recession as around the corner, you may be inclined to sit on the sidelines. If you think the market is going to shoot up for the next few years, you may be inclined to aggressively invest in the markets. I would recommend neither strategy. What you should be doing is sticking with the financial plan we put together. After all, any investment strategy is just a means to an end.

With my clients, I spend considerable time to understand their financial goals. The allocation recommendations made at that time were based on several factors including timeframe to invest, comfort with market risk, tax considerations, and many other factors. Barring any changes, I plan to continue to moving forward without changes despite any negative economic news.

As always, thank you for your time. Feel free to pass along any questions or concerns. Hopefully you know that my inbox is always open for you.