For the quarter, U.S. stocks rose sharply, with the S&P 500 gaining 13.7%. International stocks also rallied, with the MSCI EAFE climbing 10.0%. Bonds increased as well, with the Bloomberg Barclays Aggregate Bond Index rising 2.9%.
Following a steep drop at the end of 2018, the year began with a terrific rally that came close to reclaiming all of the fourth quarter’s declines. Riding the wave of a 13.7% increase this year, the S&P 500 ended the first quarter just 3.3% shy of the all-time high set last September.
In the fourth quarter, as the market entered a sudden and steep downward turn, a number of concerns were cited as the likely culprits of the decline. There was fear of a trade war with China, concerns that the Federal Reserve was raising interest rates too fast, caution about an expected deceleration in growth, and of course there was the longest U.S. government shutdown on record.
Perhaps as important (but rarely mentioned in the media) were seasonal factors that we believe contributed greatly to the decline, especially in December. First, due to the market decline, many investors engaged in “tax loss selling,” a strategy where losing investments are sold to generate losses that can offset gains and lower taxes. Secondly, mutual funds sell a portion of the their holdings at year end to make cash available for their gain distributions to investors. And finally, many hedge funds sell a portion of their holdings at the end of the year to meet redemption requests from their investors. We believe that these seasonal factors, compounded by computer driven trading, worsened the imbalance in the market and amplified the market’s decline in the fourth quarter. We also think that the end of these factors at the beginning of the new year helped fuel the market’s sharp rebound in the first quarter.
Although a handful of economic measures have softened somewhat in recent months, the U.S. economy remains quite strong by most indications. GDP grew 3% in 2018 and is expected to grow 2% this year, unemployment was 3.8% in March (well below the long-term average of 6.2%), and U.S. household net worth reached an all-time high in the first quarter, topping $109 trillion.
The most significant challenge for growth this year is that it will be impossible to top last year’s results, which benefited greatly from the tax reform legislation passed in 2017. The beneficial effect of the tax cuts will remain, but the initial boost it provided can only be reflected in last year’s results. Going forward, the comparable measures of growth will moderate, but most economists believe growth will continue for the foreseeable future.
In response to the recent market volatility and softening of some economic readings, the Federal Reserve has changed course, going from a bias towards increasing interest rates to a more neutral bias. Last year the Fed projected two to three increases in the benchmark Fed Funds rate in 2019. They now anticipate leaving rates unchanged and many investors believe that they may cut rates if economic conditions worsen.
The effect of the Fed’s interest rate increases in recent years has become evident in the yield curve, which refers to the yield of U.S. treasury bonds at various maturities. The yield curve is considered “normal” if short-term treasury bond yields are lower than long-term yields. The yield curve becomes “inverted” when short-term yields are higher than long-term yields. Due to the Fed’s increases to short-term rates and market anxieties (which have lowered long- term yields) the yield curve has become slightly inverted in some areas. This has caused added concern among some investors as an inverted yield curve has historically served as a signal that a recession may be coming in the next 12-18 months.
It is worth mentioning that March 9th marked the 10-year anniversary of the beginning of the current bull market. Since the market reached its low in 2009, the S&P 500 (including dividends) has increased 417%. During this time, the economy has expanded for 117 months, which is just shy of the record for the longest expansion in the post-war era (120 months) and is more than twice the average expansion length of 48 months.
Given the long duration of the current bull market and recent bouts of volatility, investors have become increasingly anxious. While these concerns merit our attention, we believe that the U.S. economy remains strong and will continue to grow for at least the next year. Under any conditions, it is important to remain well-diversified and remember that investing is a long-term proposition.
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Horizon Wealth Advisors is a Houston based fee-only wealth management firm. Horizon is a fiduciary advisor. We specialize in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.