Global equities and fixed income posted quarterly gains across the board with the MSCI All Country World Index and the Bloomberg Barclays U.S. Aggregate Bond Index gaining 12.2% and 2.9%, respectively. The starting point for the year was overly pessimistic growth expectations and substantially oversold conditions. The dovish Federal Reserve pivot and broadly easier monetary policy globally have fueled a forceful rally in stocks and credit spreads. Most of the drop in U.S. Treasury yields, however, came in the month of March, during which the U.S. 10-Year Treasury yield declined from 2.75% to 2.40%. Interestingly, the 10-year yield is now hovering around the average since the recovery began in June of 2009.
The rally in bonds has concerned some market participants. The narrative is that the Fed thinks growth is weaker than it seems and the bond market is sniffing that out. The historical data on Fed pauses relay a different story. In the last five times that the Fed paused a hiking cycle, both equities and bonds performed quite well. Why? With the renewed Fed dovishness, interest rate expectations reset lower and equities get a shot of gas from less worry that higher rates will choke off growth and corporate earnings (Figure 1). This has been reflected in a swift expansion of forward earnings multiples, with the S&P 500 trading around 17.0x, up from 15.4x.
The European Central Bank (ECB) appears to be following the Fed’s lead. The ECB announced that it would be holding rates at current levels through at least the end of the year and initiated a new round of liquidity operations for banks. The Bank of Japan also reaffirmed its commitment to maintain its accommodative monetary policy and the Japanese government is instituting several fiscal stimulus measures to offset planned sales tax increases.
1 Based on the Fed’s preferred Laubach–Williams measure of r*
Figure 1. 2019 earnings are declining but should remain positive for the full year
S&P 500 EPS Forecast
Source: Bloomberg and Voya Investment Management, data as of 3/29/2019
Figure 2. Voya Sentiment Indicator shows market sentiment remains neutral but moving towards overbought
Voya Sentiment Indicator
Source: Bloomberg and Voya Investment Management, data as of 3/29/2019.
Figure 3. Global manufacturing appears to have bottomed
JP Morgan Global Manufacturing PMI
Source: Bloomberg and Voya Investment Management, data as of 3/31/2019.
We are starting to see some early signs of green shoots in the economies outside the United States (Figure 3), a welcome development. A few data points worth noting have been the bounce in the China Purchasing Managers’ survey, global purchasing managers’ surveys stabilizing, albeit at low levels, and global earnings revisions bottoming. All of the above are on our list of high-frequency and rather cyclically-geared data points. We also see some signs of recovery in the U.S. housing market, which was feeling the pinch from higher rates. More data are needed, however, to turn these improvements into a trend.
With strong stock returns thus far in 2019, we expect the path forward will be a bit bumpier. Big gains tend to seep into investor psychology through a fear of missing out on potential gains. While we have seen institutional investor participation with flows into equities, retail investors have, in general, sat on the sidelines. We have seen this phenomenon play out before, thus it does not give us cause for concern, especially as the leadership of equities has been broad-based across sectors and regions of the world. Nevertheless, with a lot of good news in the price, it may mean more muted advances from here.
Earnings season is facing difficult comparisons from 2018, when the tax effects boosted corporate earnings per share. We note the expectations for 2019 earnings growth have been cut down dramatically to about 4% for the full year — three months ago that estimate was as high as 12%.
We did not make any significant changes to our portfolio in March, letting positions benefit from the tailwinds of oversold conditions. We believe the potential stabilization in the world ex-U.S. and the slowing of the pace of U.S. labor market tightening will allow risk assets to benefit from continued loose global monetary policy.
Past performance does not guarantee future results.
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