Markets shudder as a dovish Fed and sinking bond yields rekindle growth fears

Brian Nick

The last week’s market highlights:

Quote of the week:

Come listen, O love, to the voice of the dove,
Come hearken and hear him say:
There are many to-morrows, my love, my love,
There is only one to-day.”
  — Joaquin Miller, “The Voice of the Dove” (1905)
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

Policy watch: The Fed takes it easier

The Fed exceeded dovish expectations on March 20, when it held its first “live” meeting without a rate hike since September 2017. (A live meeting is one at which the Fed revises its public forecasts.) While the decision to maintain its target fed funds rate at 2.25% to 2.50% surprised no one, the accompanying statement and press conference showed the Fed’s policy stance becoming even more accommodative than markets had anticipated.
Underlying this increased dovishness is the Fed’s U.S. economic outlook, which softened slightly. The Fed now forecasts 2019 GDP growth of 2.1%, down from 2.3% at December’s meeting. At the same time, the Fed expects core inflation to remain well-anchored at 2%.
The trajectory of the Fed’s closely watched “dot plot” was much flatter than it had been in December: The Fed now foresees no rate hikes in 2019, versus two in its previous forecast. Only one increase is projected for 2020. In a further sign of looser monetary policy, the Fed said it will stop shrinking its balance sheet by the end of September, earlier than initially anticipated.
After sounding defiantly hawkish in December but far less so in January, Fed Chair Jerome Powell seems to have settled on a consistent message: the U.S. economy is still in good shape, but not so good as to require tighter monetary policy. It appears this “easier for longer” stance will be with us for a while.
Nonetheless, we’re not yet convinced the Fed will be able to get through the year without raising rates at least once. In fact, we think that both the markets and the Fed itself may be underestimating the risk that higher interest rates will once again become an issue in the second half of this year. Why? Because in an economy that appears increasingly devoid of spare capacity, it’s possible that higher input costs (wages, tariffs, borrowing costs) will feed into higher inflation.

Equities: Where does the rally go from here?

Notwithstanding last week’s downturn, in 2019 global equity markets have rebounded impressively from their fourth-quarter drubbing, with the MSCI All-Country World Index climbing 11.3% year to date. Moreover, the rise in stock prices has been relatively uniform across markets, with only the MSCI China A-Share Index (+29.3% for the year through March 22) a true standout performer. (Returns are in local currency terms.)
In the U.S., there’s been variance among different sectors but less disparity by style (growth or value) style or size (small cap versus large cap). The S&P 500’s best-performing sector has been information technology (+18.6%). Health care (+5.1%) has lagged the most. Most sector returns are bunched fairly closely together in the middle, though. Relative valuations between the U.S., the rest of the developed world and emerging markets are close to normal levels, which may help account for the lack of dispersion in returns.
Last week’s big drop in stock prices clearly reflected recessionary fears fueled by the inversion of the yield curve. But the yield curve is just one measure that we look at for gauging the likelihood of recessions. In our view, the economy’s growth path, while slower in 2019 than it was last year, is fundamentally intact: The labor market remains tight, employers are hiring and wages are rising. These are typically not harbingers of a recession. In addition, The Conference Board’s Leading Economic Index, released last week for the month of February, ticked up slightly more than expected, increasing the possibility that first-quarter economic growth in the U.S. could comfortably exceed 2%.
For equities, the primary risk is not a recession but persistent negative revisions to earnings estimates for 2019 and 2020. According to Bloomberg, consensus expected earnings for 2019 have already fallen 5.5% for U.S. stocks this year. For foreign developed- and emerging-market stocks, the declines in expected earnings are 4.5% and 7.8%, respectively.
Meanwhile, U.S. valuations—expressed as price-to-earnings (P/E) ratios—have climbed from 14.25x earnings to 16.44x earnings. Similarly, non-U.S. valuations have risen from 11.51x to 13.22x. The rising “P” for price and falling “E” for earnings in P/E ratio have made stocks more expensive. And global equity valuations may, in fact, be higher than they appear if further negative earnings revisions are on the way.
That said, we expect global economic growth, even at a slower pace, to remain supportive of overall demand, and therefore of corporate earnings. Lower earnings growth is not a death knell for stocks, but it does imply we should expect a flatter trajectory for equity markets than we’ve seen thus far in 2019.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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