Q1 2019: Key Economic and Market Insights

Advance Capital Management’s president and chief investment officer, Christopher Kostiz, provides his key economic and market insights from the most recent quarter.

After a very volatile and unrewarding year for investors in 2018, the new year started with a bang. Through March, the major stock market indices from around the world have posted very strong results. The S&P 500 Index is up 13.65 percent, the Dow Jones Industrial posted a 11.81 percent return and the MSCI All World Index returned 12.65 percent. Bonds have also bounced back from their lackluster performance last year with returns of around 2 percent for core bond strategies and 4 percent or higher for riskier bond allocations.

While several of the economic trends remain intact and serve as a ballast amidst uncertainty, several “other” pressing geopolitical and global issues can potentially either help or derail the markets and economies of the world.

Unemployment continues to fall, wages begin to rise

On the economic front, record low unemployment, healthy consumer spending and modest business activity remain the main drivers of growth. Although the most recent monthly employment report showed a gain of only 20,000 new jobs, the three-month average is still quite vibrant at about 186,000 per month, and the nation’s unemployment rate is hovering near a 50-year low. Further, employee wages are growing at their fastest pace in about 10 years, a positive sign for an uptick in consumer spending.

The latest Institute for Supply Management (ISM) report on manufacturing activity indicated a modest decline, but it is still in expansionary territory. Sixteen of the 18 manufacturing industries reported growth, the most in six months. The latest report on the services industry showed an even brighter picture. Economic activity grew for the 109th consecutive month in the non-manufacturing sector and is approaching its cyclical peak. While the report was mostly optimistic about the near-term outlook, concerns linger about the uncertainty surrounding tariffs, capacity constraints and tight labor markets.

Other sectors of the economy illustrate some volatility, yet modest strength overall. For instance, the housing market took a nosedive at the end of last year as construction plummeted across all building types and regions. However, a sharp rebound in the National Association of Home Builders (NAHB) index so far in 2019 suggests housing activity will recover in the spring. Housing permits, a barometer of demand for new construction, have increased, which suggests the recent volatility may be short-lived and due to supply and labor constraints. On the consumer side, retail sales rebounded after a surprisingly weak December that was likely due to the government shutdown and seasonal factors.

The Fed Takes a Breather

After raising interest rates nine times over the past three years, the combination of severe market volatility and weaker-than-expected economic data at the end of last year forced the Fed to alter its path to any further rate hikes. In early January, amidst softer economic data, Fed chairman Jerome Powell indicated he was willing to be flexible on policy and was in no hurry to increase interest rates further. This reassurance sparked a rebound in the capital markets during the first quarter. At the Federal Reserve’s meeting in March, it not only left interest rates unchanged, but also indicated a high probability that further rate increases were unnecessary through the remainder of the year.

Some Economic Warning Signals Are Flashing

The Federal Reserve is keenly aware that recent indicators point to a slowing economy. The tricky part is determining whether it is a temporary blip in the long-running economic expansion, or a more sustainable slowdown that could eventually cause a recession. For starters, Treasury yields are nearly the same for short and medium-term bonds. This is termed a “flat” yield curve, and should longer rates decline further, the yield curve would invert. If this occurs, it tends to be an early indicator that a recession is nearing. Next, the Fed’s own recessionary gauge, which has often foreshadowed a recession in the past, has jumped to an uncomfortable level.

While a bit unnerving for investors, the many positives still tend to outweigh these early economic warning signs. Growth remains positive and is expected to hover around 2.0-2.5 percent for the year. The employment picture is one of the best on record, with the Bureau of Labor Statistics reporting the highest job openings rate of all time. Over 7 million jobs are available, and wages are rising. Further, inflation is tame and corporate balance sheets appear sound.

Our Take

Amidst a bit more economic uncertainty and with the Federal Reserve on hold, investors have taken notice. The capital markets have bounced back so far in 2019 after a dismal performance last year. With equity markets up double digits in the first quarter, we are tempering our expectations for the remainder of the year, particularly since corporate earnings are expected to weaken. In bonds, the combination of lower interest rates and the Federal Reserve pausing on any further rate hikes should cause returns to continue to trend higher for the rest of the year. In this environment, we may make modest changes in client accounts in response to economic and market conditions.