The Brave Report: Market Commentary for April 2019

Click here for PDF version of this report: The Brave Report-April 2019

(A quick caveat to add into this report.  It was written last week (5/3/19) but with the developments in the Chinese trade negotiations over the weekend I decided to add in a small section to comment on it before sending this out.)

When is this recession happening again? While stock market performance is not a direct indicator of economic growth, it seems that investors continue to shrug off any fears of an impending recession that many pundits were preaching about only a few months ago.  Market uncertainties seem to be muted at the moment allowing strong earnings to be the focus for investors.  The reduction of earnings expectations going into the quarter and the fears about a potential rapid slowdown in earnings growth seem to have been both overdone. This has led to a continuation of the historically strong YTD market returns and near historic highs for the major indices.

Again, the fear continues to be whether the market has run too far too fast? It is inevitable that we will see some profit taking and consolidation at some point.  Will this lead to a sharp pullback or will we just see market returns slow for a few months?

Market Overview

The markets continued to add to their already historic first quarter with gains across the board.  As has been the norm, the NASDAQ was the big winner, adding around 3.6%.  The S&P500 and DOW each saw consistent gains as well, adding 2.9% and 1.7% respectively.  We have now seen four straight months of above-average gains to start the year.  While these outside gains have only brought us back around the September highs from last year, they are a far cry from where we saw ourselves around Christmas. Strong economic data and above consensus earnings data have continued to push the markets higher.  Uncertainty around a China trade deal still exists and will be back in focus as the negotiations seem to be in the home stretch. Failure to reach a deal would cause markets to pause or pullback, while a deal will again shift the focus back to corporate results and could add another leg to the rally.

After the sharp drop in rates across most of the fixed income complex last month, rates stabilized in April.  After hitting a low yield of 2.35% near the end of March, the yield on the 10-year bounced back to spend most of April trading in the 2.5-2.6% range. Like the equity side, strong economic data and corporate results seem to have muted some of the recession fear brought on by the inverted yield curve last month.

Earnings: As has been the case over the past few quarters, corporate results have been above expectations.  This quarter has been closely watched as we saw a number of revisions in earnings guidance during last quarter’s reports. The major concern was that we would see some sort of earnings recession as the stimulus provided by tax cuts last year roll off.  While overall earnings growth has been slightly negative so far this quarter, the majority of the drop can be directly tied to the one-time bump in earnings that we saw due to these tax cuts.  The first quarter last year was a bit of an anomaly as earnings were inflated substantially.

With around half of the S&P500 companies having reported earnings so far, 77% have exceeded analyst’s estimates on the earnings side. This is above the historic average but also a sign that some of the guidance revisions last quarter were warranted.

Economic Data: With the worries about an impending recession and all the uncertainty around what the Fed was going to do, economic data continues to point to a very strong economy and has added fuel to this rally.  Employment data continues to be strong with unemployment near all-time lows and labor demand strong. Even with this strong labor market, inflation has been kept in check and right around the Fed’s long-term target. While these two factors have helped to support the current market rally, the strong consumer still seems to be the major driving force behind the market returns. Consumer attitude and confidence slumped near the end of last year due to the market selloff and the government shutdown, but corporate results continue to point toward a very strong consumer and show that some of those worries were unfounded or fleeting.

While economic data has been strong it hasn’t been too strong that it forced the Fed’s hand.  Throughout 2018 the Fed raised interest rates as they tried to keep the economy from overheating.  It looks like they went a little too far near the end of the year and we are now in a somewhat goldilocks environment where economic data is strong but not too strong that the Fed has to step in and do something.  This can always change but based on the recent Fed statements, they are comfortable with the current rate environment for the foreseeable future.

Chinese Trade: (As I mentioned above, I felt the need to add this section even though the new developments took place in May.) For the past few months, all signs have pointed toward a trade deal with China being reached.  Even as recently as the end of last week, administrative officials echoed hopefulness that a deal would be reached by this Friday. This all changed over the weekend as the President tweeted out a threat to impose higher tariffs on China starting on Friday.  This was followed by the Chinese delegation threatening to pull out of this week’s high-level trade meetings.

As could be expected, markets sold off rapidly on the news.  Again, the debate is back to whether these are just last-minute negotiation tactics or something that could torpedo a deal.  I tend to think this was again just negotiations as discussions draw to a close.  Trump wants to show his strength going into the week’s trade talks.  It doesn’t seem like something that needed to be made public but as we have seen for the last few years, the President is not afraid to air his frustrations across the Twittersphere.  The hope is that these tweets don’t backfire as China might come back over the top and cancel the meeting.   I think a deal will eventually get done but I do think the risk in the short term has increased dramatically and we may see administrators walk back their hope of a deal this week.  I do expect this to just be a short-term market pullback as this type of widespread selling often reverses as the stocks that were sold but wouldn’t be impacted by any tariffs rebound.

Strategy Commentary

I added back to some of my equity positions early in the month as fear from yield curve inversion seems to have been overdone.  This maintains my equity exposure as slightly overweight.  I do think equities have run a little too far too fast and I would not fault anyone for taking some profits at any point now.  I think we end the year higher than we are now, but I don’t think the pace we are on can or will continue.  I also don’t think the move higher will happen in a straight line. There will be an opportunity at some point this year to take some profit and buy back in at a lower price.

Domestically, the only adjustment I made was adding back to my industrial exposure. I am maintaining my overweights to technology and consumer discretionary as a strong domestic consumer continue to drive both sectors.

I am still staying away from most European equities. Returns in the region have been strong this year but the upside potential and risk exposure don’t make it a favorable place to put money to work.  I am maintaining my slight overweight to Emerging Markets.  I am watching the trade negotiations closely as any Chinese exposure well be driven almost exclusively by a trade deal getting reached.

While I am not fully underweight fixed income anymore, I have still been very cautious putting much money to work in the space.  With the yield curve being relatively flat I am looking primarily at the short end of the curve for any exposure.

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