The Best First Quarter We Remember

After the worst December since the throes of the Great Depression, we followed with an almost equally strong first quarter, the strongest since the 1980s. Toward the end of the fourth quarter and into the beginning of the first quarter, we were buyers of equities, where appropriate. Our convictions were rewarded with several companies announcing strong earnings in the first quarter of 2019 and the markets moving considerably higher. There was a time we would say all of this volatility was much to do about nothing, as the market has returned to its mid-summer 2018 levels, but we think that the return of volatility belies an uneasiness in the markets of the potential for the end of this market cycle.

The pause in rate hikes by the Federal Reserve was the real catalyst to reignite the animal spirits in the market, and it likely signals a return to a slower pace of growth at best, or a stalling out at worst. However, the 10-year Treasury ended the quarter with a yield of 2.41%, which is roughly equivalent to the yield on our equity portfolios. Until we encounter worthy rates of return in bonds, we continue our preference for equities over fixed income investments in this market for long- term investors.

While we remain cautiously optimistic, and might even get excited about the stock market rebound as a return to normalcy or a harbinger of more gains, we believe there are two notable items from this rebound that deserve consideration. First, the bond market inverted the yield curve, meaning the long-term US Treasury yields declined below short-term US Treasury yields. And second, the stock market rebound was most notable in defensive sectors. While it is true that not all yield curve inversions predict a recession, it is also true that all modern recessions have been preceded by yield curve inversions. Obviously, we will only know what this environment portends from the rear-view mirror.

As we look forward, believing it is late cycle, we remain cautious in our asset allocation and security selection decisions. It does appear, especially with the Fed’s pause and a potential trade deal with China looking probable, that a soft-landing scenario with a return to slow growth may be the likely outcome. In fact, continued expansion at a slow pace is what we think is the most likely scenario moving forward.
We continue to find attractive pockets of value in the market and are relieved to see inflation still at bay and that the markets are not euphoric. It must be remembered that euphoria normally precedes market tops, and this market has been far from euphoric. Even with its huge first quarter jump, it takes us back only to the levels seen in the summer of 2018, but not to the August highs.

We see value in emerging markets, select large cap multinational companies in Europe, and US financials. We think there is still time and money to be made in the cycle, but have begun to hold more cash and slightly lowered our forward return expectations for the near-term. We believe that there will be opportunities to tactically deploy capital for long-term investors, especially as the markets digest the first quarter gains.