economic perspective

April 2019


By Thomas Dillman

Through the end of March, the S&P 500® Index was up 13%, the best quarterly start to any year since 1998.1 Most other stock markets around the world have shown similar bullishness. Mutual of America Capital Management LLC takes a close look at why the stock market experienced strong gains in the first quarter, despite ongoing trade negotiations between the U.S. and China, data reflecting a slowing U.S. economy, and other factors.

As regular readers of Economic Perspective are aware, we became increasingly cautious through most of the second half of last year for a number of reasons, including:

The Federal Reserve (Fed) was raising rates and seemed committed to continuing to do so throughout the current year.

The United States and China were locked in trade negotiations following the imposition of tariffs by the U.S. on more than $250 billion of Chinese imports, and retaliatory tariffs on the U.S. by China.

China's economy, the second largest in the world, was slowing. European growth had been slowing for over a year and showed few signs of turning around.

The European Central Bank (ECB) was on record to end its quantitative easing program by mid-2019.

The European Union faced the withdrawal of Great Britain as one of its wealthiest members and trading partners, as a result of "Brexit."

The economic data in the U.S. was weaker and below expectations during the latter part of 2018, with the exception of the labor markets.

Key Reasons behind Market Rebound

So why have markets been so robust this year? The answer is that things have changed.

After raising Fed Funds rates for the ninth time in three years to a range of 2.50% to 2.75% – despite falling markets, slowing economic data, and calls for a pause by strategists, economists and even President Trump a few months earlier – the Fed began to signal reservations about its rate policy and program to continue shrinking its balance sheet. Comments by Fed Chairman Jerome Powell following the Fed's January meeting, and subsequent publication of the minutes of the meeting, made clear that central bank policy shifted its position to a wait-and-see stance, putting rate hikes on hold for the time being. Market expectations quickly shifted in response to the change to the previous Fed guidance of at least three rate hikes during the current year. The Fed officially affirmed its position at its March meeting, signaling no rate hikes during 2019, and only one in each of 2020 and 2021. This shift in policy likely is the most compelling reason for the market's powerful advance during the first quarter of 2019.

In addition, the ECB restarted its bond-buying program, its version of quantitative easing (QE), as well as resumed reinvesting the proceeds of maturing bonds purchased under that program past the deadline that it previously set, the implication being that it will not begin raising rates anytime soon, contrary to prior expectations. Japan continued its QE program as well, while China also initiated a variety of stimulus measures, including bank interest rate reductions, tax cuts, fee reductions, bank lending increases and increases in government spending. Many other central banks around the world adopted similar measures. These steps toward looser global monetary policy are hopeful signs. One question is whether these combined actions will have as positive an effect as they did over the past half-decade. Another is whether they were initiated in a timely enough fashion to arrest and reverse the deceleration in global economic activity over the past year for most major economies outside the U.S., as well as the more recent weakness in U.S. economic data.

The response to the Fed's decision to pause rate hikes by the stock and bond markets reflects a different perspective on this policy change between the two markets. As mentioned, stocks rebounded to near new highs after an initial downturn. However, bond prices have rallied, resulting in falling market interest rates. This suggests that the stock market expects rate cuts in the near future, accompanied by a reacceleration of economic and earnings growth later this year. On the contrary, the decline in bond yields to levels not seen for more than a year implies that bond investors believe the Fed waited too long to stop raising rates and that, even if it began to cut rates soon, the probability of recession has nonetheless increased. The decline in Treasury yields resulted in an inverted yield curve, with Fed Funds and one- and two-year Treasury yields higher than Treasury maturities from two to seven years. Such a yield curve configuration preceded every recession since 1965. The weakening of economic data globally over the past couple of years, and more recently in the U.S., supports this belief. This is further corroborated by the fact that no major central bank has achieved the goal of 2% inflation.

U.S. and China Continue Trade Negotiations

Another important change versus last year is that news regarding progress on trade negotiations with China is being interpreted as more positive than only a few months ago, although a mutually acceptable deal still does not appear imminent. One positive development was the recent agreement between President Trump and China's President Xi Jinping to drop the March 1 deadline for completion of negotiations and, significantly, to not set a new one. Trump recently said he is willing to wait to get the best deal he can with China, even if that takes months.

Many commentators believe that both leaders want a deal – Xi because his economy is seriously slowing and tariffs are compounding the situation, and Trump because he needs a significant win heading into the 2020 election campaign. After unsuccessfully lobbying Congress to include the funding he wanted for a "wall" on the border with Mexico in recent budget negotiations, even after initiating the longest government shutdown in history, he needs to achieve a victory on one of his signal policy initiatives. A trade deal would be a big win for him as long as it secures most of the nontariff issues the U.S. seeks, such as cessation of intellectual property theft, enforcement of copyright and patent protection, elimination of ownership limits on U.S. businesses seeking to establish themselves in China, and adoption of reliable compliance verification procedures.

Despite the more optimistic tone of negotiations, a meeting between the two leaders originally targeted for March was deferred until a later, unspecified date. Furthermore, any trade deal would need to be approved by the Senate before the President could ratify it. The Republicans' loss of control of the House of Representatives in last November's elections, while expected, makes it even more difficult for Trump to secure policy objectives requiring legislative approval than prior to the election, as the budget negotiations and stalled ratification of the United States-Mexico-Canada Agreement (USMCA), which recently updated and revised parts of the 1992 North American Trade Agreement (NAFTA), make clear.

Economic Data a Mixed Bag

Regardless of the positive turn in these macroeconomic and geopolitical events, we remain guarded in our outlook. The global economic data remain weak and continue to deteriorate. In late 2018, the Organization for Economic Cooperation and Development's (OECD) global leading index fell dramatically and showed the first synchronized drop in the four largest economies in the world – the U.S., China, Europe and Japan – since 2009.2 The final revision of U.S. fourth-quarter Gross Domestic Product (GDP) came in at 2.2%, down from the second revision of 2.6%, and one-tenth of a percent less than expected. However, almost every component of the report showed a decline from expectations.

U.S. economic data for the first quarter continue to be weak. The current consensus first-quarter GDP growth estimate according to Bloomberg is 1.5%, and for the year it is 2.4%. However, the government shutdown delayed many important reports. As a result, economists do not have as complete a perspective as usual. However, retail sales rose 0.7% in January following a 1.6% decline in December, but fell 0.2% in February versus expectations of a 0.2% increase. Thus, the three-month average was down almost 0.4%.

Given that consumer spending accounts for two-thirds of GDP, these data are troubling. Auto sales remain well off their peaks, and housing continues to advance at a pace unlikely to contribute its usual leveraged impact on growth. January new home sales declined 6.9% versus an expectation of a 0.2% advance. Weather may have been a factor.

That said, mortgage rates have declined along with market rates, a potential spur to sales as the spring selling season begins. Durable goods and capital goods also generally remained weak; recent survey data from corporate managements indicate caution because of concern over trade and interest rates. One troubling data point reveals that, in January, business inventories rose 0.8% for the second consecutive month in a row. If that trend continues in February and March, such a buildup in inventories at the manufacturing, wholesale and retail levels could eventually lead to layoffs, undermining the one clear positive that has characterized this expansion. While inventory growth would enhance reported GDP growth in the first quarter, rising inventories without rising sales is more a sign of economic weakness than strength. The Fed's Beige Book, which compiles the observations of the 12 Federal Reserve Districts based on results from eight surveys a year, reported that only two Districts cited "growth," eight noted "slight to moderate growth," and two reported "no growth." It will be interesting to see if companies and consumers become more confident with the more positive news recently reported on trade and interest rates.

The good news is that employment remains robust (for now), and incomes, both nominal (dollars) and real (after inflation), are rising. The unemployment rate for February registered 3.8%, down from 4.0% in January, and 0.1% higher than the 3.7% low reached in both September and November of last year. Average hourly earnings growth increased sharply from just over 2.0% at the end of 2017 to its last reading in February of 3.5% – close to the peaks of 4.0% reached prior to recessions over the last 25-plus years. This does not mean that recession is imminent, because, unlike the prior periods referenced, inflation is not rising simultaneously; rather, inflation receded slightly over the past several months. In addition, the unemployment rate began to rise in advance of the last three recessions by between six and 18 months. With inflation remaining below the Fed's target rate of 2.0%, the central bank halted its rate increase program despite the strength in the labor markets. The theory that tighter labor markets yield rising wages, which in turn increase consumer prices, has been discredited in this expansion so far.

As with the case of GDP growth, corporate earnings are expected to show a significant slowdown versus last year's historically strong results. First-quarter S&P 500® earnings are expected to decline nearly 4% versus last year's first quarter. Current consensus estimates for the remaining three quarters of 2019 are gains of 0.8%, 2.1% and 8.4%. In other words, analysts' estimates embody what we suggested was the stock market's expectation of a reacceleration of growth in the second half of the year. However, the trend continues to show fewer earnings increases than cuts, with the ratio of increases-to-cuts lower than the long-term historical average despite a recent uptick.3

Despite the recent several months of decelerating growth data and lowered corporate earnings expectations, the stock market seems to want to look beyond any further near-term weakness based on hope and expectation that the Fed's pause and potential cut in rates, along with monetary easing by other central banks around the world, will revitalize and extend the already historically long expansion. Such a scenario played out during the expansion of the 1990s, when the Fed cut rates on two different occasions in response to threats to the expansion, which ultimately lasted for 10 years. If a significant trade deal with China is reached, which incorporates reliable and enforceable compliance measures, then prospects for the global economy would brighten further. The market response would probably be positive, as well.

Thomas Dillman is the former President of Mutual of America Capital Management LLC.


Savita Subramanian, Bank of America Merrill Lynch, "U.S. Performance Monitor," April 1, 2019.


Chris Low, "FTN Financial, Am Morning Comments," March 11, 2019.


Savita Subramanian, Bank of America Merrill Lynch, "Revision Ratios: Improving Trends," March 28, 2019.

The views expressed in this article are subject to change at any time based on market and other conditions and should not be construed as a recommendation. This article contains forward-looking statements, which speak only as of the date they were made and involve risks and uncertainties that could cause actual results to differ materially from those expressed herein. Readers are cautioned not to rely on our forward-looking statements.

Mutual of America Capital Management LLC is an indirect, wholly owned subsidiary of Mutual of America Life Insurance Company. Mutual of America Life Insurance Company is a registered Broker-Dealer.

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