“The stock market may swing from euphoria to misery, but you aren’t obliged to share its moods.” —Jason Zweig, “The Intelligent Investor,” Wall Street Journal
The market’s swings of the last few months have given Mr. Zweig, who writes frequently about how our brains can interfere with sound investing, plenty of good material. After a dramatic fall in December, the market rallied at the start of the new year, continuing that rally into April. Although trade tensions with China have weighed heavily on the market in early May, that does not mean we as investors should be throwing in the proverbial towel. In fact, it’s worth remembering that stocks captured more than a typical year’s worth of gains in the year-to-date period through April.
Spring took hold in more ways than one last month. The market rally that began late last year continued into April—buoyed by stronger consumer confidence, better-than-expected corporate earnings, job growth and the Federal Reserve’s dovish turn on interest rates. The market also seemed to price in (albeit prematurely) a resolution to the trade war—which, as we’ve seen lately, can make it more vulnerable to saber-rattling by the world’s two largest economies.
The S&P 500 index hit a new record high in April, gaining 4% for the month and more than 18% for the year-to-date period. The index posted a 13.5% return for the trailing 12-month period. To put these gains in perspective, the long-term average return of the S&P 500 is about 7% yearly.
The small-cap companies that make up the Russell 2000 index also gained some momentum earlier this year, rising 3.4% in April and 18.5% for the year-to-date period. On a trailing 12-month basis, though, the Russell 2000 still lagged the broader market, returning less than 5% through April.
Non-U.S. stocks also turned a corner earlier this year, reflecting the fact that economic growth in foreign markets (as measured in part by manufacturing activity) appears to be on more-solid footing than it was late last year. The indices representing developed markets (MSCI EAFE) and emerging markets (MSCI EM) gained nearly 3% and about 2%, respectively, in April, and more than 13% and 12%, respectively, year to date. The indices remained in negative territory on a trailing, 12-month basis.
US Sector Scorecard
Financial, Technology, Communication Services sectors outperformed in April — returning 9%, 6.4% and 6.5% respectively.
The Financial sector has been lagging the broader market for some time, but it caught a tailwind in April after fears of a recession faded. Financial-services companies came under pressure in March after the U.S. Treasury bond yield curve briefly inverted—i.e., the yield on the 10-year Treasury fell below the yield on the 3-month Treasury. Longer-dated bonds typically have much higher yields than shorter-dated bonds—which only makes sense, as investors want to earn more in exchange for having to wait longer to get their money back. An inversion of the yield curve is often a sign that the economy is headed into recession, but the first quarter’s inversion proved short-lived, reversing itself after just a week. The about-face helped to boost investors’ appetite for banks and other Financial sector companies.
The Healthcare and Real Estate sectors fared worst in April, declining by nearly 3% and 0.5%, respectively. Keep in mind, though, that Real Estate — which had a tepid year in 2018 owing to investors’ concerns over the impact of rising rates on the sector — has done well this year, returning 17% year to date and more than 21% for the trailing 12 months through April. Healthcare, a strong performer over the last couple years, paused in April. Healthcare-related companies became some of the first casualties of the new election season as presidential candidates targeted pharmaceutical and managed-care companies.
Against a backdrop of rising stock prices, the bond market, which has rallied modestly this year, lost some momentum in April. The broad-based Bloomberg Barclays U.S. Fixed Income Aggregate index was flat for the month, after rising nearly 2% in March. Performance was particularly weak on the long end of the Treasury yield curve, with the Bloomberg Barclays 10-20 Year Treasury index falling into negative territory.
Yet bonds posted solid returns for the year-to-date and trailing 12-month periods ending last month. The Bloomberg Barclays U.S. Fixed Income Aggregate index gained 3% and more than 5%, respectively. High-yield (or junk) bonds fared best in the risk-on environment that prevailed before trade tensions produced market volatility in early May.
The U.S. bond market has benefitted this year from a strong dollar—which provides a drag on non-U.S. assets—and 10-year Treasury yields that, while still low by historical standards, have been among the highest in the developed world on a nominal and real (or inflation-adjusted) basis.
The Economy and the Fed
April brought warmer weather and some sunny economic news. The Commerce Department reported last month that U.S. economic growth reaccelerated in the first quarter. Gross domestic product—the value of all goods and services produced in the U.S., adjusted for inflation and seasonality—rose at a 3.2% yearly rate in the first quarter, which marked the strongest rate of first-quarter growth in four years. The robust uptick in GDP marked a stark departure from 2018, when GDP growth weakened over the course of the year. The Commerce Department also reported last month that retail sales rose by nearly 2% in March, the biggest increase since September 2017.
Other areas of the economy produced mixed signals. For instance, the Institute for Supply Management reported that its U.S. manufacturing index fell to 52.8% in April, from 55.3% in March. April’s reading—while still positive—represented the weakest growth in factory activity since October 2016. A reading above 50 generally indicates an increase in manufacturing activity and vice versa. Declining export orders are among the factors that have contributed to slower factory activity.
Even with economic growth accelerating in the first quarter, inflation is still playing a game of “Where’s Waldo?” In other words, you know it should be out there—after years of low interest rates and unemployment—but you just can’t find it. So until Waldo’s signature red-and-white striped shirt becomes obvious, the Federal Reserve must remain vigilant for signs of inflation while still being sensitive to the potential of a slowing economy.
In addition to the tos and fros of inflation, the Fed must face political challenges as well. In April, President Trump nominated two politically minded individuals to the relentlessly neutral central bank’s Board of Governors. Both nominees eventually withdrew from the process, but the president’s very public pressure represents a marked departure from the executive branch’s traditional hands-off approach to monetary policy and, in my view, a troubling trend. The Fed’s strength comes from its political independence, and attempts to erode that independence risk undermining the market’s confidence in the central bank.
As we’ve stated in prior commentaries, we believe that we’re closer to the latter stages of this economic cycle than we are to its beginning. While nearly 80% of companies have reported better-than-expected earnings for the first quarter, many have been able to top expectations by cutting expenses—as they are prone to do late in the business cycle when growth becomes scarcer.
For the near future, the market may continue to swing from euphoria to misery depending on trade negotiations. Yet we must remember that both sides are eager to finalize a deal. In the U.S., the looming presidential election will no doubt put some pressure on Mr. Trump to strike an agreement. China, meanwhile, is eager to see its economy return to stronger levels of growth and emerge from its trade-war-induced slowdown. As Mr. Zweig suggests, we do not need to act on these mood swings. In fact, successful investors are advised to look through these ups and downs to the more important longer-term path ahead.
Live richly and invest well,
Kara Murphy, CFA
Chief Investment Officer
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S&P 500 Index:
A broad based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a capitalization-weighted, unmanaged index that is calculated on a total return basis with dividends reinvested. The S&P 500 represents about 75% of the NYSE market capitalization.
Russell 2000 Index:
This index measures the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks; ; the index serve as a benchmark for small-cap U.S. stocks. .
MSCI Europe, Australasia, and Far East (EAFE) Index: This index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada.
MSCI Emerging Markets Index: This index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of June 2009 the MSCI Emerging Markets Index consisted of the following 22 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
Bloomberg Barclays U.S. Aggregate Bond Index: A market capitalization weighted bond index of investment grade U.S. dollar-denominated fixed- income securities.
US High Yield Corporate:
The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
US Investment Grade Corporate: The Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers.
Bloomberg Barclays Municipal Bond Index: The Bloomberg Barclays U.S. Municipal Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. Gold (spot): Gold price per ounce in US Dollars.
S&P 500 GICS Sectors Level-1: In 1999, MSCI and S&P Global developed the Global Industry Classification Standard (GICS), seeking to offer an efficient investment tool to capture the breadth, depth and evolution of industry sectors. GICS is a four-tiered, hierarchical industry classification system. It consists of 11 sectors, 24 industry groups, 68 industries and 157 sub-industries. Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity. MSCI and S&P Global use revenues as a key factor in determining a firm’s principal business activity. Earnings and market perception, however, are also recognized as important and relevant information for classification purposes, and are taken into account during the annual review process.
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