Following a tumultuous close to 2018, US stocks rallied sharply in Q1 as the S&P 500 Index gained 13.6%. This is the biggest quarterly gain since 2009 and its best start to a year since 1998, which followed the biggest quarterly decline since 2011 in Q4. There were a number of factors behind the rally, most notable were a softening policy stance by the Federal Reserve and constructive US-China trade negotiations. US Treasuries also rallied as the yield on the 10-year note fell more than .25% to just over 2.41%. The yield curve continued its flattening trend late in the quarter with the spread between three-month bills and ten-year notes inverting for the first time since 2007. The brief inversion of the yield curve was a slight concern as the quarter came to a close.
What was most influential to the stock market strength was the dovish pivot on the part of the Fed, indicating that it was inclined to refrain from increasing the federal funds’ target interest rate range for the foreseeable future. As you may recall, investors’ main concern during the Q4 2018 selloff was that the Fed was tightening too aggressively and that it could tip the economy into a recession. The impetus for the softened policy stance centered on core inflation not breaching the central bank’s 2% target.
Expectations for a trade deal between the US and China ratcheted higher in Q1. Although a deal hasn’t been reached, the trade talks with China continued with signs of a favorable resolution in sight.Heightenedexpectations for a trade deal between the US and China was another high-profile tailwind.
The inversion of key segments of the US Treasury yield curve late in the quarter raised concerns about recession. However, while caution is warranted, most economic indicators are not signaling a recession. Rather, the economy stands on solid footing with unemployment still at a 50-year low with wage growth picking up. Bespoke Investment Group pointed out that in the years after the last four inversionsthe S&P 500 was positive every time with gains of at least 9%. Historically, recession is telegraphed when the 2-year Treasury note yield is higher than the 10-year note yield.
Looking towards the remainder of the year, I suspect the Fed is likely done raising interest rates this year with a slight chance of a rate cut. The period we are in reminds me of 1994-1995 timeframe when the Federal Reserve, led by Chairman Alan Greenspan, was raising rates throughout 1994 only to cut them in July of 1995. Like 2018, the stock market in 1994 went through wide gyrations and bottomed in December that year and rallied significantly higher in 1995. I caution, however - markets don’t exactly follow the past but often rhyme.
Please let me know if you have any questions about the markets or your portfolio. Again, thanks for your confidence.