Time is Relative – Market Update, 1st Quarter 2019

Most of those reading this update are of a generation that was born and raised well before the Internet. We can remember buying something from a catalog or cereal box and having to wait six weeks for our special purchase to arrive. Let’s imagine that you mailed your order, marked the wall calendar for six weeks out, and, lo and behold, your purchase arrived three days later! Besides being elated and dumbfounded about how this happened, what would you do next? Would you wait five more weeks to open it, tell the postman to return it or just enjoy the early gift? Most of us would likely enjoy the very early gift. Well, that is how we should feel about the great start financial markets have had this year. It’s a gift! Whether it is early depends on your time frame. Let’s explain.

If you focus on just the US large cap stock market (S&P 500 Index) since the late 1920s, the index has returned approximately 10% per year. Yet, rarely does the index return close to that amount in a calendar year. Instead the market’s calendar years vary between extremely strong returns, slightly positive returns and negative returns, resulting in the “average” outcome of approximately 10%. So, with the S&P 500 up 13.1% in the first quarter, it feels like investors’ hoped-for annual return came in the mail much earlier than expected. But last year we did not get a “present” from the S&P 500, as it lost 4.4%. Thus, if one adjusts the starting time frame to the beginning of last year, the S&P 500 Index is only up 8.6%. That 15-month period is below average despite the hot start to 2019. Instead of the first quarter’s returns being an early gift, maybe the markets just made up for stiffing us in 2018 and the S&P 500 still owes us more positive returns before we get back to the average.

We could look at more numbers and different time frames, but that makes for very boring reading. The bottom line is that the ten-year period from 3/2009 to 3/2019 (market bottom of 08’-09’ crash until now) was one of the best periods of returns for US large cap stocks ever, with the S&P 500 averaging a whopping 15.9%. At some point things are bound to change. Bull markets do not last forever. Luckily, apart from a briefly inverted yield curve, current economic indicators do not point to an imminent recession for the US, which is typically what brings the end to an extended bull market.

The good news in the first quarter was not limited to strong returns for US stocks. Despite worries about slowing economic growth abroad and the ongoing trade/tariff dispute, foreign markets posted strong results as well. If trade deals get finalized and we enter a period of “trade peace,” international markets should benefit even more than US markets. We believe this to be the case since a much larger portion of most foreign countries’ GDP comes from exports than in the US. For instance, the US gets 8% of its GDP from exports, while the Eurozone gets 20% and China gets 19%. This is a huge incentive for foreign countries to negotiate with the US and why most experts think the dispute will come to an end sooner rather than later.

The Federal Reserve gave us more good news. The government entity that controls short-term interest rates not only said that they will stop raising the fed funds rate for now but will also stop reducing the amount of debt on their balance sheet. These moves are bullish for the economy because it means there is ample money available for companies and individuals to borrow at reasonable rates. These moves also implied that rates should remain low for the foreseeable future, which led to a first quarter bond rally. More early gifts.

If everything sounds too good to be true, maybe it was. But just as the market rallied more than it should have in the first quarter, it likely sold off more than it should have in the fourth quarter. Today, the markets seem complacent after a strong first quarter. It is important to remember that despite the strong economy and friendly Fed, we are late in the bull market and the economic cycle. This is typically a time of increased volatility and choppy markets. We are constructive on the markets, yet cautious. We see this rally as an opportunity to rebalance your portfolios. We will take capital from outsized gains and redeploy it prudently across other asset categories based on the risk profile of each investor. We are not sure what the rest of the year will bring but are planning on enjoying our early “gift.”

Sources: JP Morgan and Morningstar

Mike Kauffelt, CFA
Co-CIO, Bill Few Associates, Inc.