PMC Weekly Review – May 13, 2019
A Macro View – April Monthly Recap
The rally in the domestic equity markets, which looked to be losing momentum in March, returned with a vengeance in April. An upside surprise in first quarter gross domestic product (GDP) and a stronger-than-expected first half of corporate earnings season were the primary drivers, boosting stocks across the board. The government shutdown in the early part of the first quarter had reduced expectations for GDP growth to around 2.50%, but the first estimate was significantly stronger at 3.20%. Meanwhile, following a difficult fourth quarter, earnings expectations were revised downward for the first part of 2019, only to have these muted expectations exceeded by a wide range of companies as reports rolled in across the month of April. Banks were the big winners of earnings season, and Financials rallied to lead S&P 500 Index sectors for the month. Mega cap tech stocks continued their winning streak, while the overall economic optimism resonated through economically sensitive sectors such as industrials.
Growth continued to outpace value in the large and midcap markets in April. The Russell 1000 Growth Index was up 4.50% in December, outpacing the 1000 Value Index by nearly 1.00%. The midcap markets were the best performers for the month, as the Russell Midcap Growth Index rose 5.50% vs. a 3.30% return for the value- oriented version of the index. Somewhat counter-intuitively, small cap stocks were the laggards in April and the only space where value outperformed growth. The Russell 2000 Value Index was up 3.80%, roughly 75 basis points ahead of the growth index. This performance was driven largely by the growth index’s significant weight in the Health Care sector, the only sector with negative performance, due in part to universal health care as a hot issue in the Democratic primaries. The value index’s largest single sector, on the other hand, is Financials, which showed strong leadership in April.
The international equity markets rose slightly during April but lagged their US counterparts. The EAFE Index was up 2.80%, and similar to the domestic markets, growth outperformed value. Brexit negotiations continued during the month, ultimately being pushed back to October to allow for more time to negotiate the UK’s exit from the European Union (EU). The European Central Bank (ECB) cut its 2019 EU growth forecast to 1.20% from an already modest 1.30%, as substantial downside risks to the growth outlook remain. Despite the gloomy economic outlook and political threats to the EU, stocks in Europe rose 3.60%, outpacing the remainder of the developed markets. Primary factors included a strong start to the first quarter’s earnings season in the region and the increase in sentiment around Europe’s second-largest trading partner, China, whose stimulus package began to have a positive impact on Chinese growth.
Stocks in emerging markets countries, up 2.10%, trailed their developed markets counterparts. Results in China were modestly positive, rising 2.20%, as markets priced in positive developments in trade negotiations with the US. However, some economic activity showed signs of flagging. The purchasing manager’s index weakened from 50.5 in March to 50.1 in April, and exports from China fell 2.70% in the month compared with one year earlier. It appears China is feeling the pinch of a slowing global economy. Latin America as a region was marginally positive at 0.40%, despite a 7.90% loss in Argentina for the month.
The domestic fixed income markets were largely flat in April, with the US Government/Credit Index returning five basis points and the Aggregate Index up just three basis points. Although credit posted relatively strong returns of 49 basis points, mortgage-backed securities, down six basis points, and Treasurys, declining 28 basis points, both experienced negative price pressure, as the yield curve steepened on modestly higher growth expectations for the global economy. Credit spreads were largely unchanged in the investment grade space, just two basis points tighter than at the end of March. The high yield market continued its rally from the first quarter, rising 1.40%, as spreads compressed by roughly 30 basis points on average in April. The bank loan market was even stronger with the S&P Performing Loan Index up 1.80%.
The municipal market was similarly quiet with the 1-5 Year Index up just two basis points and the 1-15 Year Index up 20 basis points. Technicals in the municipal market remained strong, as new supply is down 28% this year compared with the first four months of 2018. Demand for tax-free funds in April continued at a near record pace, as municipal bond funds as a whole took in more than $6 billion after taking in $27 billion in the first quarter. However, short-term municipal bond funds had outflows of slightly more than $1 billion, as investors pulled out money to pay their annual tax bills. This pushed short-term yields slightly higher, while intermediate and longer term yields fell in conjunction with the taxable market. These technicals are expected to continue to drive the market for the next few months, as cash from maturities and early calls this summer, the vast majority of which will need to be reinvested, are estimated to significantly exceed the amount of new supply.
Sovereign credits in developed markets were down roughly 80 basis points in dollar terms in April, as bond yields rose across much of Europe and Asia, reflecting improving market sentiment. The yield on the 10-year German Bund rose eight basis points, returning to positive territory with a yield of 0.01%. Central bankers remain cautious, even with this modest rise in rates. ECB President Mario Draghi continued to indicate that rate hikes are unlikely through the remainder of 2019, and the ECB stands ready to use appropriate tools to move inflation closer to its 2.00% target. Bank of Japan Governor Haruhiko Kuroda indicated that rates would not be raised before the spring of 2020, introducing a time frame to its “extended period” comments for the first time. Kuroda also continued to express concerns over slowing growth and weak developments in inflation.
Nathan W. Behan, CFA, CAIA
Senior Vice President, Investment Research
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