Market Data for the quarter ended March 29, 2019:

• S&P 500 Stock Index: 2834, up 13.0%
• Ten-year Treasury Note Yield: 2.41%, down .27%
• Gold: $1,299 per ounce, up 1.4%
• Oil: $60 per barrel, up 33.3%

Stocks enjoyed their best quarter of returns since 1998, as relief from worries about the future path of Federal Reserve monetary policy and trade tensions between The United States and China sent investors back into the market they had fled from in the fourth quarter of 2018. At the same time, interest rates fell across the spectrum on concerns the global economy was heading into a pronounced slump if not outright recession in the months ahead. This presents investors with a state of cognitive dissonance, with stocks and bonds offering differing views on the state of the economy. Resolution of this dissonance will be the central theme of the second quarter.

As referenced above, the stock market was propelled higher by the Federal Reserve’s updated outlook for monetary policy and easing of trade tensions between the United States and China. A major factor in the collapse of share prices in the fourth quarter of 2018 was concern that the Federal Reserve was too aggressive in its policy of raising interest rates and reducing the size of its balance sheet. Early in the new quarter, Federal Reserve Chairman Jerome Powell indicated the Federal Reserve would adjust its policy in a more accommodative direction. At its March policy meeting, this proved to be the case. After having predicted in December two quarter point increases in the benchmark federal funds overnight interest rate for 2019, the Fed said that the likelihood was that there would be zero. Furthermore, they stated that their balance sheet reduction would be completed in September after stating in December that it was open ended. This was music to stock investors’ ears. The stock market’s view that the Fed may push the economy into recession was replaced with the belief that the Fed could help maintain an ongoing economic expansion.

Furthermore, on trade, the view of the stock market has become that a trade agreement between the United States and China is likely. President Trump waived his March 1st deadline for a deal, and it is seen by many, (including the Chinese), that he is motivated to want a deal to continue the rally in the stock market, which he views as validation for his economic policies. While a conclusive agreement has proven elusive thus far, the stock market has taken solace in the softening of rhetoric coming out of the White House, helping to send shares higher. Trade tensions and tariffs have suppressed investment and weighed on the global economy, so a cessation of hostilities would be copacetic.

The bond market, however, has taken a less sanguine view of the economy than stock investors. Global economic data has been disappointing this year, particularly in Europe and China, which could ultimately weigh on the United States and corporate profits. On March 22nd, the Treasury yield curve “inverted.” This means the interest rate on three-month Treasury bills was higher than that of ten-year Treasury notes. This has happened nine times since the end of World War Two, and of those nine times, seven have been followed by a recession within the next two years. We do not believe a recession in the near-term is inevitable, but at the very least the economy is markedly decelerating.

The dilemma investors must resolve is whether a slowdown in the economy can support higher share prices. Based on our work, the stock market is on the expensive side of fair value, so disappointment and poor returns moving forward are a distinct possibility. Incumbent for a positive resolution to the dilemma is that trade relations between the United States and China do not further deteriorate. As stated above the stock market sees an agreement as likely, but President Trump is nothing if not mercurial. (Witness his recent threat to close the US-Mexican border.) An escalation of trade hostilities would darken market sentiment and almost certainly send share prices lower.

That having been said, market and economic conditions are rarely, if ever, clear or predictable. As such we remain committed to our core strategy of quality, value, diversification, and patience, which has served us well over the long-term. Regardless of the resolution of the dilemma described above, we remain confident that we can continue to deliver superior risk adjusted returns. For the remainder of 2019, we see the stock market, as represented by the S&P 500 stock index, to trade in a range of 3000 to 2500. It ended the first quarter at 2834.