(stock indices are before dividends; yield and rate changes are absolute changes)

The same can be said of the first quarter as the fourth quarter – what a difference a quarter makes, but in a much better way. The US stock market bounced back strongly, posting the best quarter since mid-2009. International markets were decent but still have not fully shaken off a rough start to the prior year. Strong buying pushed the benchmark Treasury rate to its lowest level in 14 months and the long-anticipated inverted yield curve (the 10-Treasury rate compared to the 3-month Treasury rate) finally showed up on March 22.

Concern for a slowing economy caused the Fed to announce in its March meeting that there will probably be no further rate hikes through 2019 and maybe one hike in 2020; they had previously signaled two hikes in 2019. The Fed will also slow the reduction of its balance sheet in May (that is, slow down their sale of bonds) and will end the process in September. The question is whether the Fed will retain short-term or long-term Treasuries, which could impact the bond market and rates. The GDP estimate for 2019 was lowered to 2.1% from 2.3% and the unemployment forecast was increased slightly from 3.5% to 3.7%. The Fed chairman also noted that the US government was on an unsustainable fiscal path regarding the growing deficit.

At the same time, interest rates in Europe are falling even more in the face of weak growth. The European Central Bank kept their rates at 0% (the rate for bank deposits held at the ECB are already negative) and announced a new loan program for banks. The ECB also cut their 2019 GDP forecast to only 1.1% from 1.7% in December. The US trade deficit hit its highest monthly level since 2008 as exports were down and the full impact of trade tariffs are still being digested and exports to China were down 20% in February.

Fourth quarter GDP growth came in at 2.6%, above expectations, with the full year of 2018 at 2.9%. Consumer spending was generally strong but was down in December due to RV’s and autos, temporarily increasing the savings rate to a healthy 7.6%. Inflation is still tame, with all measures hovering around the 2% level on an annual basis. Productivity finally picked up, with the last nine months of 2018 being the best nine-month stretch in eight years. Still, productivity growth has only averaged 1.3% in the current expansion compared to a post-World War II average of 2.1%. Indicators for both the services and manufacturing sectors showed growth but at a slightly lower rate. Hourly earnings grew 3.4% and unemployment drifted back down to 3.8% as jobless claims remained low.

After a tough couple of years, homebuyers may be getting a break. From nearly 5% in November, mortgage rates have slid to a national average of 4.06% and supply of existing homes for sale increased 3% from a year prior. Price growth slowed for 10 straight months, with the median new home price actually falling, and bidding wars are much less frequent. Still, closed sales were down over the last 12 months and housing starts remain sluggish.

The UK made the US political rancor seem downright friendly with their inability to finalize their departure from the EU. Parliament defeated Prime Minister May’s proposals for a Brexit three times and also failed to even agree on a customs union with the EU. The biggest problem is the real possibility of a “hard border” between Ireland, which remains part of the EU, and Northern Ireland, which as part of the UK would leave the EU. This has raised fears that the Irish peace of the last 20 years could be put in jeopardy. Even with an extension of the Brexit deadline to April 12, the rest of the EU is preparing for a hard Brexit.

Looking Forward

The future direction of interest rates could be part of Looking Froward every quarter but after the yield curve inverted in March it’s worth taking a look at what that really means. Many headlines say that an inversion “always” leads to a recession, usually within 18 months. But as usual there is more to the situation.

The yield curve inverted for the first time since 2007 as the three-month yield changed very little since the last Fed increase in December but the 10-year rate slid on heavy investor demand. That demand was fueled by concerns over slowing not only in the US but in Europe and China and the potential effects of trade wars and the disruption of a hard Brexit. The last seven recessions were preceded by an inverted curve, leading to its status as a reliable indicator. An inverted curve shows that the market expects the Fed to cut rates, which it does to stimulate growth, restoring a sloped curve.

But there were two recent instances, in 1998 and 1965, when the curve inverted, the Fed cut rates and the economy continued to grow. (Yes, recessions eventually occurred but due to other factors.) And in the current interest rate environment, the typical “term premium” (a normal difference between the 10-year and three-month rates) has been squeezed by the Fed’s participation in buying bonds since the recession. So there has been a structural difference in the market which has made the curve flatter for years.

An inverted yield curve has been much less predictive of recessions in other economies and provided no advance warning of the harsh 2008 recession in Germany. While some research has confirmed that the 10-year/three-month comparison is the best pair of interest rates to use, it also may depend on how long the curve inverted. A more cautious evaluation would look for the inversion to last up to three months.

The curve first inverted on March 22. Yields jumped up on April 1, ending the inversion, although the curve is still very flat. Let’s see where the curve, and the economy, goes from here.

Our Portfolios

Technical investment analysis is a trading discipline based on analyzing trends and charts based on trading activity like price movement and trading volume. It differs dramatically from fundamental analysis, which seeks to evaluate an investment’s intrinsic underlying value, and quantitative analysis, which focuses on data related to an investment’s financial statistics.

A basic technical tool is the “moving average” which takes a longer period (often 50 or 200 trading days) and creates a rolling moving average of that period. The idea is that the longer period smoothes out daily fluctuating and represents a longer trend.

On March 19, a bullish “golden cross” appeared when the 50-day moving average, which had fallen with the December market decline, crossed the 200-day moving average. Technical analysts believe this marks the transition from a shorter rally into a longer uptrend. Great news for investors!

Just 3 months earlier, on December 19, the market had given the opposite indicator – a “death cross” with the 50-day moving average going below the 200-day. Sure enough, the market dropped 6.6% in the three days after that death cross.

Unfortunately, the market was 11% higher when the golden cross showed up than it was for the death cross. In simple terms, that means that if an investor acted on the death cross and exited the market, not to return until the golden cross appeared, he would have given up an 11% return that would have been realized by just staying invested the entire time.

That’s the problem with many indicators; they work one way but not the other and the net impact often turns out to be damaging to the investor.

At worst, technical analysis is the investing equivalent of tea leaves and chicken bones. At best, any advantage it may provide is short-lived. While we are aware of and occasionally acknowledge technical indicators, we do not make portfolio decisions based on technical analysis.

As for the dramatic market movement the last two quarters, it is yet another example of a “V” reversal in which one sharp move is followed quickly by a move in the opposite direction. 2018 also started with a “V” but inverted, with the market shooting up in January and then falling precipitously over two weeks.

The danger of a V recovery is that it can create unrealistic expectations for investors. Many investors are unfazed by declines because “the market always comes back” and that is a healthy outlook for the long term. But a market recovery can take years, not weeks or months, and when a slower market recovery arrives it will be critical to keep that long-term view and not become disillusioned.

Two Milestones

There were two significant milestones this quarter. On March 9, 2009 the S&P 500 closed at 676.53. In the 10 years since, the S&P 500 has returned well over 17% annually and gained $17.5 trillion in overall market value. The 120-month increase is 310% and the next longest bull market since the Great Depression was 113 months from 1990 to 2000, during which the S&P 500 increased 471%.

Individual sectors and companies have fared quite differently in this bull market. Consumer discretionary stocks performed best, followed by information technology; both performed 10 times better than energy, the laggard. The biggest contributors to the S&P 500 (that is, grew the most in total value, including market value and dividends) were Apple and Microsoft, at total annualized returns of 32.65% and 25.218% respectively. JP Morgan Chase was third at 23.42% annually and even General Electric, which has struggled mightily lately, returned 6.57% annually, mostly from dividends.

The best performers in percentage terms were Ulta Beauty at 53.79% annually and medical implant device maker Abiomed at 51.90%, with Netflix a close third at 51.75%. Only nine companies in the S&P 500 had negative total returns over the ten-year period, with CenturyLink posting a -6.56% annualized loss.

The second milestone is more transformative and was a major part of the first. In fact, this development has transformed almost every aspect of our business and personal lives. Thirty years ago, computer scientist Tim Berners-Lee of the Swiss research lab CERN published a proposal for a “web” of documents that could be viewed through a “browser”. This is considered the inception of the world wide web even though the first web pages did not go live until August 1991.

Some interesting tidbits about the world wide web on its 30th birthday.
• Berners-Lee was not pursuing some grand vision in his proposal; he had just gotten tired of having to switch computers to access information that was not on his main work computer.
• The internet and the world wide web are not the same. The internet began as early as 1969 when computer scientists at UCLA got two computers to send data to each other for the first time. The web made the technology more user-friendly and accessible to the public.
• The first website that became live at CERN in 1991 has been updated several times and is still online.
• The first image ever shared on the web in 1992 was a photo of Les Horribles Cernettes, a comedy band of other CERN employees.

Ironically, as the web has evolved into something beyond anyone’s wildest dreams, Berners-Lee has publicly lamented the opportunity created by the web for scammers, criminals and those who spread hatred. He has urged everyone to fight to minimize the negative consequences of the web.