The last week’s market highlights:
Quote of the week:
“Oh, to be in England now that April’s there.” — Robert Browning
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2019 Outlook :
- U.S. economy: A slowdown, not a recession
- Global economy: Amid lower expectations, emerging markets could surprise to the upside
- Policy watch: Fewer tailwinds, stronger headwinds
- Fixed income: Rates likelier to rise than fall
- Equities: Late cycle but good value
- Asset allocation: A neutral stock-bond view
The first quarter in review: Investors say, “Whew!”
Investors should be pleased when they review their first-quarter statements. U.S. stocks rebounded smartly from their fourth-quarter decline, with the S&P 500 jumping 13.7%—its best three-month start to the year since 1998. Overseas markets also recovered handsomely in the period. Europe’s broad STOXX 600 Index returned 12.3%. Bolstered by China, the MSCI Emerging Markets Index advanced 9.9%.
That said, stock market gains were concentrated in January and February, rewarding investors who maintained their equity allocations in the new year rather than join the retreat amid the barrage of negative economic headlines in late 2018. The global equity market rally ran out of steam in a volatile March punctuated by disappointing U.S. jobs growth and weak data releases from China and Europe.
But in an example of “one man’s junk is another man’s treasure,” global sovereign bonds rallied in March on the downbeat data and a steady diet of dovishness from major central banks, including the U.S. Federal Reserve and the European Central Bank. With the Fed signaling no rate hikes in 2019 and the risk of higher near-term inflation dissipating, investors snapped up U.S. Treasuries, sending the yield on the bellwether 10-year note down from 2.61% on March 19 to a 15-month low of 2.39% on March 27. (Bond yields and prices move in opposite directions).The 10-year closed at 2.40% on March 29, down 4 basis points (0.04%) for the week and 29 basis points for the quarter.
Across the Atlantic, the yield on the 10-year German bund ventured further into negative territory during the week, finishing the quarter at -0.07%. Germany added to the $10 trillion pool of negative-yielding global bonds on March 24, issuing 10-year debt with a below-zero yield for the first time since late 2016. The ramifications of buying negative-yielding debt seem ominous. Investors who bought at last week’s auction and hold the bonds to maturity are guaranteed to recognize a loss. On the flip side, though, investors could profit if they sell their holdings after yields fall further, a distinct possibility given today’s uncertain backdrop.
So what do we expect in the second quarter? Probably a lot less of the same. Equity valuations have risen substantially both in the U.S. and abroad, making another period of double-digit gains highly unlikely. Moreover, the U.S. first-quarter earnings season has gotten off to a slow start. Of the 105 S&P 500 companies reporting through March 28, 73% have delivered negative earnings guidance, above the 5-year average of 70%.
In fixed-income markets, high yield credit spreads—the difference between yields on high yield corporate bonds and Treasury securities—have narrowed considerably, leading to the strongest first quarter for high yield bonds (+7.3%) since 2003. The downside is that these bonds, like stocks, are not nearly as attractively priced as they were in January.
We do see reasons for some optimism at the macro level. Representatives from the U.S. and China continue to negotiate, and reports surfaced late last week that China has made unprecedented proposals on thorny issues such as forced technology transfers. And despite the recession fears recently triggered by the inverted yield curve, there are no signs the U.S. economy will contract in the near future.
Brexit: Third time’s not a charm
On Friday, March 29, the day on which the U.K. was originally scheduled to leave the European Union (EU), Parliament voted 344 to 286 against Prime Minister Theresa May’s third try at passing a Brexit deal. Previous versions of her proposal—which the EU approved late last year—were rejected by members of Parliament (MPs) in January and in early March.
With this defeat, the state of Brexit has perhaps never been more uncertain. After vowing last week to resign if Parliament backed her deal, May will now have to slog along a little longer. Earlier in the week, Parliament was given a choice of eight alternative versions of Brexit. These included a “crash out” Brexit (one in which the U.K. departs the EU without a plan in place), a “do over” voter referendum and even canceling Brexit altogether. Remarkably, none of these amassed majority support from MPs. If one simple futile gesture could represent the entire Brexit enterprise, this lack of consensus was it.
In the absence of an agreement with the EU, the U.K. will either have to leave without a deal on April 12, which would be chaotic and unpopular. Another unsavory option would be to ask the EU for a much longer extension. This would not only require the consent of the other 27 EU members, it would also merely kick the Brexit can down the road.
What might happen during such an extension is unclear. New elections or a fresh referendum are both possible. Perhaps a more hardline Brexit PM would attempt to negotiate a full trade deal with the EU, making obsolete the need for May’s stop-gap plan. A new Labour Government might push for a softer Brexit or even a second public vote, potentially leading to abandoning the endeavor altogether. Whatever happens, it’s obvious that Brexit has not gone according to plan.
Fortunately, financial markets seem to have shrugged off the Brexit brouhaha—for now. U.K. stocks rose 1% last week, bringing their year-to-date advance to a healthy 8.2% (Returns are in local currency terms.) And while the value of the British pound edged lower versus the U.S. dollar last week, it’s up by almost 2% for the year to date.