First Quarter 2019 Marks the Best Start to the Year Since 1998…Our View on What’s Next
Apr. 8, 2019 Commentary

First Quarter 2019 Marks the Best Start to the Year Since 1998…Our View on What’s Next


Curley: “You know what the secret to life is? One thing.” 

Mitch: “What’s the one thing?”

Curley: “That’s what you have to figure out.”

-- Dialogue between characters played by Jack Palance (Curley) and Billy Crystal (Mitch) in a key scene in the 1991 box office hit, City Slickers

In terms of the raw performance data, we believe the first quarter of 2019 was absolutely outstanding. The S&P 500 Index advanced more than 13 percent1.  This represents the best first quarter for this benchmark since 1998and its best three-month period since the quarter ending September 2009.3 The index posted positive returns in January, February and March. This is only the 19th time this has happened since 1950.4  

And, it wasn’t just the S&P 500 that saw good results. Virtually all the major equity indices generated healthy positive returns. Specifically, the tech-laden NASDAQ advanced more than 16 percent, the small-cap-focused Russell 2000 was up slightly more than the S&P 500, and even international equity indices, both developed country (MSCI EAFE) and emerging market (MSCI Emerging Markets), were up by more than 11 percent. Stock investors of all stripes cheered in early 2019. In fact, with 10-year Treasury yields falling 28 basis points in the quarter and 65 basis points over the last two quarters,5  the old TINA (There is No Alternative) argument for stocks was resurrected… stocks once again look quite attractive versus bonds, simply when comparing the dividend yield of the S&P 500 to bond yields.

What made this first quarter stock performance scenario even sweeter was that it came on the heels of December 2018, during which time the S&P 500 experienced an intra-month pullback of 19.9 percent, which was advertised in the media as, the worst December since 1931. This carried implications that more downside was to come, and the mood was somber at Christmas time. As you know, we held high conviction at that time that the headlines were way too negative, that the Santa Claus market swoon was a normal correction, and that we were expecting healthy returns for the S&P 500 in 2019. While it would be quite normal to see a bit of a pause for several months or even slight short-term retrenchment after a sharp rally like this, we still feel that way. In our January Market Outlook, we assigned a 75 percent probability that the S&P 500 would end the year in a range of 2,800-3,000. We believe it is likely we will fall at the upper end of that range. So, we see upside from here.

For statistics junkies, there’s some interesting historical data on this. Per Strategas, in the years when all three months of the first quarter posted positive returns, the S&P 500 generated an average gain of 9.6 percent in the ensuing nine months, albeit with an average intra period correction or pullback within that nine-month period of 9.4 percent.6  So, it’s not off to the races in a straight line, but this historical data is pretty good – nearly double-digit returns, but with normal volatility. We’re not basing our outlook on history rhyming here, however. Our positive view is based on the still-healthy economic and market fundamentals. While fundamentals are more grind it out in nature than robust, generally moderate, steady economic and earnings growth is healthy for stocks.

That “One Thing” That Everyone is Talking About—An Inverted Yield Curve

You would think that investors would be feeling pretty good after seeing the nice gains we just outlined, especially since we’ve received some much improved news on the Fed policy front and news that sounds like progress in talks with China about tariffs and trade. Actually, sentiment is rather somber and cautious at this time. Yes, some of this angst is associated with the need for confirmation of good outcomes on both the Fed and Trade, but most of it can be attributed to just one news headline at the end of March. The headline that the yield curve has inverted is being bantered about like it’s some binary outcome event. It’s being implied that everything is just fine if the yield curve is positively sloped, but as soon as it goes negative, look out, it’s over! If only the stock market was that easy.

This is what reminded me of that great scene with Curly and Mitch in City Slickers. The scene where Mitch (city slicker from NYC) is searching for the meaning of life during his dude ranch getaway, only to have Curly (tough, dude ranch cowboy) tell him that it boils down to “one thing.” Curly says, “Stick to that, and everything else don’t mean sh##.” Clearly, Mitch is amused by this conversation, but he realizes finding that one important thing is way more difficult than portrayed by Curly. I guess if there was just “one thing” at a high level to live by in stock investing, it would be, “Pay little attention to the headlines.” When it comes to identifying the key indicators that signal economic and market outlook, plurality comes into play. There aren’t dozens of effective indicators to follow, but there is more than one. We look at several key indicators to build a mosaic, or a comprehensive, view to make judgements.

Theoretically Speaking, What Does the Shape of the Yield Curve Tell Us?

The yield curve is typically positively sloped in a normal economic environment. In other words, 10-year treasury yields are generally higher than two-year treasury yields, as investors normally expect economic growth and some associated level of inflation. The longer the term of the bond in a positive growth environment, the higher the risk that the Fed may have to hike the fed funds rate someday to cool things down, and that general interest rates rise in tandem across the board. Given their reluctance to take on this rising interest rate risk, fixed income investors must be incented to purchase bonds longer out on the curve in this environment, via the higher rate, rather than just play it safe and stay at the short end of the curve. The key is that flat to positively sloped yield curves tend to signal economic growth and to be stock market friendly.

On the other hand, inverted yield curves tend to be unfriendly to the stock market, with a lag if they stay inverted for some sustainable period of time. Specifically, they are considered an indicator of possible recession. The rationale as to why an inverted yield curve signals potential recession is straightforward. If 10-year Treasury rates are lower than two-year Treasury rates, we believe this illustrates investors’ willingness to buy bonds longer out on the curve with confidence that rates are likely to fall in a slowing economy. Expecting the Fed will have to cut rates in the future to stimulate the economy, investors are most willing to purchase longer dated bonds and lock in at current rate levels, bidding up their price and causing their yields to fall below current rates of shorter-dated bonds.

So, Did the Yield Curve Invert?

We’d have to say yes and no to this. The data is mixed and inconclusive, in our opinion.

The three curves that are worthy of watching closely are: 1. The three-month to 10-year slope, 2. The one-year to 10-year slope, and 3. The two-year to 10 year slope. Each of these has gone negative prior to the last eight recessions, and on March 22, 2019,7  the first two of these (the three-month to 10-year and the one-year to the 10-year) went negative for one day. This commands our attention. That said, the following points are important to understand regarding why we do not interpret this as a nasty signal that the yield curve has patently inverted:

  • The three-month to 10-year and the one-year to 10-year inverted on a daily basis only on March 22, 2019. As of April 1, both are positive again. Just like one number a trend does not make, one day an inverted yield curve does not make. The average monthly spread would have to go negative before we would call this a sustained inversion.
  • The two-year to 10-year spread, which is the yield curve we key on, is still positively sloped. The chart below shows how it stacks up on an average monthly basis versus prior recessionary periods. Notice the current positive slope versus negative spread in these prior periods.8

Unlike Other Periods, the Monthly 2-10yr Spread has Not Inverted

  • The longer end of the curve, the 10-year to 30-year, is very positively sloped, unlike prior recessionary periods when it went flat to negative.
  • U.S. rates are anchored by the exceptionally low foreign rates. On average, 10-year U.S. treasury rates are 1.4 percent higher than that on a basket of foreign bonds of similar maturity. In prior periods of yield inversion, U.S. 10-year rates were trading 0.8 percent lower than this basket of foreign bonds. This time, foreigners are flocking to the higher yielding U.S. bonds, and the strong demand is driving higher bond prices and lower U.S. yields. The strong dollar is making this strong demand even stronger. Far from signaling U.S. recession, this foreign buying that is pushing down U.S. spreads is actually signaling foreign investor confidence in U.S. growth relative to their economies.

Not One Thing—It’s a Mosaic

Even if the two to 10-year yield curve goes negative, we still suggest caution in taking this as a sign to immediately reduce equity positions. First, based on history, there is plenty of time. The chart below illustrates that the yield curve, on average, goes negative six to 22 months in advance of a recession.9  For example, the three to 10-month curve inverted in July 2006, yet the S&P 500 continued to climb 29 percent over 15 months before topping out on October 9, 2007.10

 Source: J.P. Morgan US Equity Strategy and Quantitative Research

Exiting early can be costly. That’s why we look at a number of other effective signals and indicators that all look positive right now and stand in contrast to the cautionary sign of the “maybe/maybe not” inverted yield curve:

  • The Leading Economic Indicators Index improved in February and remains at high levels.

Source: The Conference Board

  • Wage growth is rising and unemployment is low, which is atypical of pre-recessionary periods.
  • Credit spreads are low and well contained; normally they widen significantly heading into recession.
  • Unemployment claims data spikes prior to recessions, yet the U.S. is close to decade lows on this measure.
  • The Purchasing Managers Indices for both manufacturing and service sector industries are both at healthy levels and signaling growth; both have gone negative prior to previous recessions.


In a nutshell, the preponderance of evidence remains positive, as do we. When the weight of the data shifts, we will adjust our view. One thing alone, with mixed signals, doesn’t cut it for us.


2The Wall Street Journal
3The Wall Street Journal
5Barron’s April 1, 2019
7The Wall Street Journal
8J.P. Morgan U.S. Equity Strategy, March 29, 2019
9J.P. Morgan U.S. Equity Strategy, March 29, 2019
10Barron’s, March 25, 2019

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