At the end of 2018, interest rates were heading higher due to a hawkish Federal Reserve (FED); both global trade and manufacturing were slowing as the trade war raged on; and earnings expectations were being revised down. This led investors to conclude that the economy was slowing both abroad and here at home. Due to all of this, global equities, represented by the MSCI ACWI Index, suffered their eighth worst¹ quarterly loss in 30 years.
What a difference three months can make! Today, the bear has run back into its cave, the Fed has turned dovish, interest rates have plummeted, and stock markets have mostly recovered. The first quarter of 2019 was the best quarter for global equities since 1998 and the 11th best of all time!² It was a similar story for the S&P 500; after falling ~13.8% in 4Q18, the index rebounded 13.1% and at quarter end sits about 3.3% from its all-time highs. While the drawdown and rebound pattern occurs fairly often, what is unique was the magnitude and speed of this cycle. Since World War II, no other correction/bear has fallen as far and rebounded as fast as what we have just witnessed.
Dovish Fed: Is the market overreacting to the upside?
In 2018, as the decidedly hawkish FED continued to raise interest rates, they were projecting several more increases in 2019. In addition, their policy on reversing the trillions of Quantitative Easing (QE) remained in place. As interest rates rose across the yield curve, the economy clearly had trouble digesting these changes and it was most readily apparent in the housing market. Interest rates rose to the point where they broke a 35-year downtrend. Mortgage rates were rising which choked new and existing home sales. Trouble in the housing market, and other cyclical sectors in the economy, caused investors to begin to worry about a slowdown in the economy as a whole, and stock prices reacted accordingly.
In the first quarter of 2019 the FED stopped raising rates and told the world that future rate increases were on hold. In addition, they outlined a plan to stop QE-reversal and stated that their balance sheet would remain at levels more than four times higher than those prior to the Great Recession (accommodative monetary policy remains). As we wrote to Chairman Powell, this was a welcome reversal and it set the stage for the markets to recover. Our concern is that just as the market likely overreacted to the downside in 2018, it may also have overreacted on the upside so far in 2019. Stock markets often overreact as the human emotions of fear and greed work their magic.