The rebound in equity markets continued in February as the S&P 500 increased by +3.2% and is now up +11.5% year-to-date – the best start to a calendar year since 1991. The market has now gained back nearly all of December’s losses. Recall that 2018 included a near bear market (peak-to-trough decline of -19.8%), the first calendar year loss since 2008, and the worst December monthly return since 1931. The strong start to 2019 is not because all the issues facing the market in late-2018 have quickly evaporated. Rather, we believe that last year’s selloff was another example of how markets can be extremely volatile and sometimes irrational in the short-term. In February, the news flow on the market’s current most important topics, the economy, US/China trade war, and Fed policy was generally positive (see below for details).

Our equity market outlook remains balanced as we do not believe this is the time for excessive risk taking or extreme caution. We will publish a full market outlook along with our Q1 2019 recap next month. We would move to a more optimistic stance if the US and China agree to a trade deal where all tariffs are rescinded, the Fed remains accommodative, and/or global economic growth starts to accelerate. We would turn more cautious if trade talks breakdown, the Fed turns hawkish, and/or economic data begins to deteriorate. We acknowledge that markets and risks can change quickly, and we will continue to monitor new developments.

International markets produced positive results as Developed International (MSCI EAFE) markets increased by +2.6% while Emerging Markets (MSCI EM) gained +0.2%. Within Fixed Income markets, bonds declined slightly as the Barclays US Aggregate Bond Index decreased by -0.1%.

We’d like to highlight three key events of February 2019:

Q4 2018 GDP – Growing but Slowing

The United States economy ended 2018 at a solid pace as Q4 GDP came in at a +2.6% seasonally adjusted annual rate. The report was better than the expected +2.2% consensus estimate. Consumer spending, which accounts for about two-thirds of the economy, increased by +2.8% and was driven by health care, financial services, and insurance spending. The current economic expansion is set to become the longest on record in mid-2019.

Economists expected economic growth to moderate in late 2018 and through 2019 due to weaker global growth and the fading effects of fiscal stimulus. GDP growth in the second and third quarters of 2018 came in at +4.2% and +3.4% respectively. The current Bloomberg consensus estimate for 2019 GDP growth is at +2.5% Y/Y, which would be a deceleration from 2018’s +2.9% Y/Y level.

The first GDP estimate for Q4 2018 was originally scheduled to be released on January 30th, but it was delayed by a month due to the government shutdown. The Commerce Department estimated that the government shutdown lowered Q4 growth by about -0.1%. The agency also cautioned that the full effects of the shutdown cannot be fully quantified.

Obligatory Trade Update

The US and China moved closer to reaching a trade agreement throughout February as extensive negotiations yielded positive results. A US delegation traveled to China in the middle of the month while talks resumed in the Washington the following week. The latest round of trade negotiations went well enough that talks were extended for an additional two days. In a positive sign that the two sides are moving closer to a deal, President Trump agreed not to implement the previously scheduled tariff rate increase of 10% to 25% on $200 billion worth of Chinese goods.

Reports indicate that a deal could be finalized at a meeting between President Trump and President Xi as early as mid-to-late March. The two sides are working toward a comprehensive deal that addresses currency, agriculture, non-tariff barriers, technology transfer, and intellectual property. If a deal is signed, what happens to the current tariffs remains a major question. Tariffs could remain in place for a period until there is verifiable evidence that both sides are following the terms of the agreement or they could be rescinded immediately. The trade war will remain a major stock market risk and a drag on the global economy until an agreement is signed and all tariffs are eliminated.

FOMC Minutes

The Federal Open Market Committee (FOMC) minutes from the January meeting shed some light on the Fed’s new “patient” and “flexible” approach. Recall that in January the Fed pivoted from their December of 2018 approach by stating they would now be patient with future interest rate increases and flexible with their balance sheet runoff program. The January minutes stated that patience would allow the Fed more time to assess the US economy, inflation, ongoing trade war, and the economic slowdown in Europe and China. Most investors expect the Fed to pause interest rate increases until at least the second half of the year.

The big news from the FOMC minutes was that the Fed will announce a plan to end their balance sheet runoff in late-2019. Fed Chair Powell recently stated that “we’re going to be in a position to stop the runoff later this year and my guess is we’ll be announcing something fairly soon.” The minutes indicated that the Fed was somewhat puzzled that investors partially blamed the balance sheet runoff for the stock market decline in December 2018. The Fed noted that the balance sheet reduction plan was communicated well in advance and had been proceeding smoothly for more than a year. A formalized plan to end the balance sheet runoff could be announced at the March 20th FOMC meeting.