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Market Outlook -- April 2019


Richard Clarida, vice chairman of the Federal Reserve’s Board of Governors, spoke to an audience of bankers to discuss the current economy along with the group’s outlook. He described the economy as achieving both areas of the Federal Reserve’s dual mandate: price stability (stable inflation) and employment. The unemployment rate – which is currently near a 50-year low – is forecasted to fall further to 3.7% by year-end. The clarity provided in the Federal Reserve’s balance sheet plans (lower reinvestments into Treasuries and mortgage-backed securities through September followed by all reinvestments into treasuries) allows the committee to now focus on the correct maturity range to purchase.

The outlook for global growth in 2019 from both the Federal Reserve and International Monetary Fund (IMF) call for economic growth to moderate from 2017 and 2018 above-trend levels to 3.3% in 2019. Major contributors to slowing global growth include financial reforms in China, softer German production after stricter environmental regulations, and deteriorating global trade relations. Many of these items are expected to be resolved in the second half of 2019, global growth is forecast to improve to 3.6% in 2020.

Equity markets

During March, large-cap companies (S&P 500) outperformed small-cap Companies (Russell 2000) returning 1.94% and -2.09% respectively. Both international developed (0.74%) and emerging market (0.87%) indices improved in March. Equities recorded their worst weekly decline during the first week of March as headlines around global growth and the European Central Bank’s (ECB) decision of further stimulus to aid bank lending growth. Later into the month, housing data showed negative sales and construction results despite the fall in mortgage rates. Chairmen Powell spoke on the struggle taking place as inflation has remained below the Fed’s 2% target. Market participants interpreted his remarks as being accommodative towards growth, pricing in a greater likelihood of an interest rate cut, rather than increase in 2019.

Research from JP Morgan signals a positive surprise for first quarter earnings results for the S&P 500. Their view is that the downward revisions to earnings since January (estimates typically fall -3.3% during the quarter; in Q1 estimates fell 7.7%) have overestimated earnings declines. JP Morgan is calling for earnings to increase between 3% and 5% for the S&P. Considering the different sources of returns, the run-up in equities for the first quarter (S&P 500 returned +13.6%) was attributed to multiple expansions. Said another way, future earnings of the S&P 500 are more expensive relative to levels in January. Higher valuations will place a greater emphasis on future earnings growth in the quarters ahead.

Fixed-income markets

Economic measures such as factory orders, wages, unemployment and confidence continue to soar. The positive data is not driving increases in reported CPI and PCE inflation, however, which seems to be a disconnect. CPI change year-over-year is only 2%, and March posted only a muted 0.15% increase. All the while, entry level wages are reported to be near $11 to $12, versus minimum wage of $9.45 (in Michigan). While inflation will remain close to Fed target rates (2.0%), there will be some pressure on CPI rates to move higher as pricing power returns to manufacturers, higher oil prices move through the system and wages remain elevated. For the bond market, the curve should continue to steepen (from near flat conditions) with the most change at the long-end (10 to 30-year segment) of the yield curve. The 10-year Treasury bond yield may move to 2.8% - 3.0% from 2.6% now, as sustained growth reverses the recent technical move lower in rates. 

Tax-exempt bonds have outperformed their U.S. Treasury counterparts across the yield curve as supply versus demand dynamics continue to richen the market. March marked the fifth consecutive month of positive performance for muni’s, with the Bloomberg Barclays Municipal Bond Index posting a total return of 1.58%. The technical backdrop remains strong; however, the relatively rich valuations may serve as a headwind going forward. The 10-year muni-to-Treasury ratio continues to reach new lows, despite year-to-date municipal issuance 19% higher than the same period last year. The 10-year ratio has consistently moved lower since the beginning of the year to reach its current decade low (rich) level of 76.3. Given the current environment, we prefer the short-end of the curve, favoring lower quality investment grade credits and revenue vs. general obligation bonds.

Alternatives/Real assets

Monthly U.S. oil production increased 2.5% in March to 12.1 million barrels/day (mb/d) and is forecast, by the U.S. Energy Information Administration (EIA), to average 12.4 mb/d in 2019. More broadly, global production, reported by the International Energy Agency (IEA), increased 1.5 mb/d year-over-year to 99.7 mb/d. Through February, year-over-year production by OPEC members was down 3.5% to 30.7 mb/d. Collectively OPEC members have achieved 94% of the production cuts previously agreed to.

The IEA is forecasting global oil demand of 100.6 mb/d in 2019, running slightly ahead of the current global supply of 99.7 mb/d. If the supply continues to run below production, oil prices could see upward pressure. The EIA forecast an average price of $2.76/gallon through September. For 2019, prices should average $2.60. If correct this would represent a savings of $100 over the year, representing the first annual decline in 3 years.

Securities offered through Rehmann Financial Network, LLC, member FINRA/SIPC. Investment advisory services offered through Rehmann Financial, a Registered Investment Advisor. 

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