Key Market/Economic Observations
Reprise on Numerous Macro Fronts Allows the Market and Investors to Refocus on the Fundamentals
After a volatile few months, many of the major risks affecting financial markets have eased considerably. For example, the Federal Reserve’s (Fed) dovish pivot, largely optimistic trade headlines, and better-than-feared fourth-quarter earnings have allowed investors to recalibrate sentiment to match the solid fundamental backdrop of the U.S. economy. While meaningful improvements should continue offering a path higher for equities, these factors remain top of mind for us in 2019. With such a strong start to the year, it would not be surprising if the still fairly complex macro backdrop led to a market pause over the near term.
International Developed Markets
Improved Investor Sentiment Lifts Markets while Global Economic Outlook Remains Uncertain; Brexit Clock Continues to Tick
Despite ongoing global trade tensions and softening global economic data, international developed markets were able to carry their positive momentum from January into February as the MSCI EAFE index climbed another 2.1%, bringing the index’s year-to-date performance to 8.8% as of February 21. To date, performance has been entirely attributable to a sharp improvement in investor sentiment, evidenced by rising price-to-earnings multiples. While the global stock relief rally continues, it is possible the investor sentiment pendulum has shifted too far to the bullish side, discounting the reality of slower global growth. Additionally, Brexit negotiations have made little progress as the March 29 deadline rapidly approaches. While we believe the probability of a hard Brexit is low, the uncertain path continues to weigh heavily on the U.K. economy.
Lunar New Year Ushers in the Year of the Pig, a Symbol of Prosperity and Wealth
Emerging market (EM) equities cooled off in February; however, the primary driver was South African equities (6% weighting in the MSCI EM index), affected by federal budget issues. Asian EM equities are actually positive on the month, led by China and Taiwan consumer and information technology stocks. Chinese markets were also supported by a surprise jump in corporate credit growth for the month of January. While the ¥3.23 trillion in new credit both exceeded consensus estimates and was the largest volume on record, the data may be materially affected from seasonal timing of the Lunar New Year, as the year-over-year growth rate was actually in line with the five-year average.
Less Synchronous Commodities Extend Recovery in February despite Dollar Strength
The Bloomberg Commodity Index extended gains in February, bringing year-to-date returns to 6.87%. The energy subindex continues to lead, up almost 15% year to date, as OPEC crude oil production cuts and unforeseen outages have outweighed record U.S. production. This has served to allay concerns of a renewed crude oil glut in 2019 despite weakening demand expectations. Industrial metals also ticked higher, up 9% year to date and breaking through the 200-day moving average, supported by increased optimism on trade negotiations and supportive supply/demand dynamics. In agricultural commodities, high inventories continue to weigh on prices, with the subindex falling more than 1% in February. However, there is some cause for optimism, as China offered to purchase an additional $30 billion in agricultural goods, above pre-trade-war levels, which could offer a reprieve from swollen inventories. Ultimately, we continue to view less dollar strength as key to a sustainable path higher for commodities and inflation, which will likely require a stabilization in international economic growth expectations.
What does the Fed Pause Mean for Portfolios?
The Fed’s decision to take a more cautious approach to future interest rate hikes has been a boon to risk sentiment in 2019, pulling credit and equity markets well off their 2018 lows. This is similar to past market reactions following a pause in the Fed’s rate-hiking cycle; however, we expect volatility to remain elevated as we progress through the later stages of the business cycle. While the Fed has provided an easier path forward, the lagged effects of interest rate hikes are likely to linger throughout 2019. Soft landings after a Fed rate hike cycle are indeed possible, as seen in the 1984 and 1994 cycles, so there is cause to examine the historical path of the economy following a Fed pause. This month, we analyze these dynamics and the historical impact to financial markets and investor portfolios.