The first quarter was a welcomed turnaround for the financial markets following the fourth quarter setback.  The bull market reignited in late December and caught fire in January.  Momentum waned as the quarter unfolded, but each month produced positive returns for stocks and bonds.  For the three month period, the S&P 500 gained 13.7% and the Barclay’s Aggregate Bond Index netted 2.9%.

The Federal Reserve played a key role in the market reversal as they pivoted to a dovish position on monetary policy.  The year began with the market expecting the Fed to continue to raise the fed funds rate with regularity, but Chairman Powell proclaimed patience was the new path forward.  His statement was interpreted to mean zero interest rate hikes in 2019 and the markets immediately rallied.  The Fed’s new policy perspectives coupled with other encouraging news sent stocks soaring once again.

Fourth quarter earnings season was deemed a success with corporate earnings growing 13.4% making it the fifth consecutive quarter of double digit growth.  Future earnings growth will likely settle into single digit territory.  Employment data was exceptionally strong in December and January, but was offset by a disappointing 20,000 jobs created in February.  March’s employment number will confirm if this was a one-time event or a new trend toward less job creation.  The current 3.8% unemployment rate and growing wages still suggest a strong labor market.  The end of the government shutdown was another bullish catalyst.  A trade deal with China was anticipated all quarter, but now a deal is needed soon to meet market expectations.

The major stock indices had a great start to the year with U.S. stocks outpacing international stocks.  The bull market in U.S. stocks turned ten years old this March, a new historical milestone.   The NASDAQ Composite, S&P 500 and the Dow Jones Industrial Average had sizable gains of 16.8%, 13.7%, and 11.8% respectively in the first quarter.  Evidence of slower economic growth in international economies did not deter stock appreciation in those markets.  The MSCI EAFE and emerging markets indices still produced gains of 10.0% and 9.9% in the quarter.  This has been a traditional rally where growth and small capitalization stocks outperformed value and large capitalization stocks.

With stocks having a tremendous first quarter, one would expect bonds to be on the decline.  This was not the case as interest rates and the shape of the yield were remarkably stable to begin the year.  After the Federal Reserve meeting in March, the bond market rallied hard into quarter end.  The combinations of the Fed’s revised policy leanings, continued low inflation, declining global interest rates, and stable economic growth brought a new optimism to the bond market.  The Barclays Aggregate Bond Index gained 2.9% in the quarter.  High yield bonds, beneficiary of a strong stock market, led all fixed income sectors with a 7.3% quarterly return.  The benchmark 10-Year U.S. Treasury note traded in a tight range, then rallied, declining 28 basis points to end the quarter yielding 2.41%. The yield curve enjoyed a bullish flattening, as long-term interest rates fell more than short-term interest rates.  For the quarter, the 2-Year Treasury fell by 21 basis points to end the period yielding 2.27%.  Meanwhile, the 30-Year Treasury also fell 21 basis points to yield 2.81%.  Most of the yield curve now has interest rates lower than the very short-term fed funds rate currently set at 2.5%.

The financial markets are adept at stirring investor emotions through unexpected price volatility and price momentum.  The past three quarters provided a roller coaster ride from market highs to a double digit correction and back to market highs again.  Hopefully, you let your portfolio ride along while keeping your emotions on the sidelines.  The best approach to long-term investing is to stay invested at a portfolio risk tolerance that reflects both your financial goals and personality.   We are still optimistic on stocks and bonds for the remainder of the year.  After this very successful quarter, do not extrapolate these results through year end.  If stocks can add an additional 5% and if bonds can hold these gains, 2019 will be deemed a successful year for the financial markets.

MARKETS BY THE NUMBERS:

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

The market has had a strong beginning to 2019, with the S&P 500 up over 10% year-to-date.  Within sectors of the market, there has been significant divergence of performance.  Below is a chart that reflects relative performance of the 11 sectors against the S&P 500 since the beginning of the year.

• Technology, Industrials and Energy sectors have outperformed the market
• Consumer Staples, Health Care, and Utilities have underperformed the market

On the other hand, the sectors that have outperformed in 2019 are significantly different from those that performed well during the downturn from September to December 2018.  The chart below reflects relative sector performance to the S&P 500 during that timeframe:

• The sectors that have underperformed in 2019 (Consumer Staples, Health Care, and Utilities) were 3 of the 4 best sectors to own during the downturn.
• The outperforming sectors of 2019 (Technology, Industrials, and Energy) were 3 of the 4 worst performing sectors during the 2018 downturn.

Historically, the sectors that are outperforming in 2019 have been considered more “cyclical” as they tend to benefit from a rising economy.  The sectors underperforming so far in 2019 have been traditionally viewed as “defensive” compared to other segments of the economy.  This trend has been a reversal of sector performance trends seen at the end of 2018.  These types of rotations can happen swiftly and timing these trends can be very difficult to do in practice.

As these two time periods indicate, performance can vary widely within sectors based upon changing investor sentiment.  Even with the traditional “defensive” versus “cyclical” definitions, independent drivers of growth (example: manufacturing activity for industrials, rising interest rates for financials) can create different levels of performance.  While timing sectors can be challenging, it is important to monitor portfolio positioning within sectors to understand the sensitivity to various drivers of market performance.  Lastly, maintaining diversification within sectors creates a risk managed approach that can reduce the overall volatility of the portfolio.

(Performance data from StockCharts.com)

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Officially, the current bull market in the US started on March 9^th, 2009. That means this week marks its 10^th anniversary. A few facts on this bull market are highlighted below*:

• The S&P 500 is up 401%
• Annualized return has been 17.5%
• Earnings growth accounted for 73% of the S&P 500 returns
• Price to Earnings (P/E) multiple expansion accounted for 19% of the S&P 500 returns
• 10 stocks accounted for 25% of the performance over this time, led by Apple

The current bull market will come to an end when the S&P 500 drops 20%+ from a peak to a trough. That hasn’t happened yet, but came close to it twice:

• in mid-2011 when the S&P dropped 19.4% from its high
• in the last quarter of 2018 when the S&P dropped 19.8% from its high

Here at Gradient Investments we repeatedly discuss that the trajectory of corporate earnings is the biggest driver of stock prices over time. I think the current bull market endorses this. S&P 500 earnings grew from $67 in 2009 to $161 today. This has accounted for nearly 73% of the gain in the S&P 500. On top of this, P/E multiples have risen from 10 times to 16 times, aided by the low interest rates we’ve had for the last 10 years.

The point is, if you find good companies cheap that you believe will display good earnings growth going forward, you’ll most likely do quite well. Below is a list of the top ten stocks that contributed to the performance of the S&P 500 the last 10 years (percentage point contribution is boxed in green):

Most market watchers believe the bull market started in March of 2009 and technically they are correct. But in my opinion the real bull market didn’t start until mid-2013, making this current bull market only about 5 and a half years old. The period between March of 2009 and mid-2013 the market was making up for the losses it experienced during the financial crisis. See the chart of the S&P 500 below:

Regardless of when you think the bull market started, a better question is how long will it last? That of course will depend on how the fundamentals (the economy, earnings growth, valuation) are doing. Currently, it is our opinion that the US economy is still strong, earnings are forecast to grow mid-single digits in each of the next couple of years and valuations are reasonable. Until that changes we are still constructive on the US stock market.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.