Second-Quarter Stock Market Performance Hinges on Economy, Yields, Trade Deal

The major U.S. stock indexes finished the week with a surge and the quarter in spectacular fashion. The buying even spread to the global equity markets. After suffering through a steep sell-off from October to December, the markets rebounded during the first quarter helped by the Federal Reserve’s shift in its opinion on rate hikes, better-than-expected earnings results, and optimism that the U.S.-China trade deal would end with a strong deal in place.

For the week, the benchmark S&P 500 Index settled at 2834.40, up 1.2%. For the quarter, it was up 13.1%. The blue chip Dow Jones Industrial Average settled at 25928.68, up 1.7%. It finished up 11.2% for the quarter and the technology-based NASDAQ Composite settled at 7729.32, up 1.1%. It was up 16.5% during the first quarter.

All Ships Rise with the Tide

The broad-based, large-cap stock indexes performed well during the first quarter, led by the S&P 500 which recorded its strongest quarterly performance in a decade, rising 13% and leaving the index just 3% off its all-time high, according to Bloomberg.

However, with the prospect of lower interest rates looming, Small- and mid-cap stocks actually outperformed large-cap stocks, which in turn outperformed international stocks. The jump in value makes sense since small- and mid-cap companies tend to borrow more money to function so they tend to benefit the most from lower interest rates. Large-cap stocks, on the other hand, are being capped by lost revenue due to the trade dispute.

Energy stocks also performed well during the first quarter because of a 30% surge in oil prices following the OPEC-led production cuts and U.S. sanctions against Iran and Venezuela. This led to an overall increase in commodity prices.

Lower Volatility in March

Stocks closed higher for the month, while relatively low volatility prevented major swings in either direction. Let’s just say it trended upward most of the month, while being peppered with a few volatile downswings.

Analysis from Bloomberg for March shows the stock market only saw three days in which there was a move of 1% or more, compared to nine such days in March 2018. For some perspective, March 2013 had zero 1% daily swings, while March 2009 has a remarkable 15 (71% of all trading days in the month).

Factors to Consider in the Second Quarter

During the second quarter, stock market investors are likely to pay the most attention to the economy, the yield curve and U.S.-China trade negotiations.

Last week, it was reported the U.S. economy expanded at a 2.2% pace in the fourth quarter, U.S. GDP growth for 2018 finished at 2.9%. The 2.2% number was lower than the fourth-quarter growth of 4.2% and 3.4% growth during the third-quarter.

The number shows some economic fatigue, but growth is still expected to come in at the mid-2% pace this year.

Also last week, much emphasis was put on the inverted yield curve because of its high correlation to future recessions. Stocks managed to finish the week higher despite these concerns. This was probably because it’s just an indicator. Furthermore, it may take 6 to 18 months before there is a recession. So while investors were paying particular attention to this signal, an impending recession is far from assured at this time.

The drop in yields took place because the Fed had just signaled it was going to refrain from further rate hikes in 2019. Portfolio adjustments had to be made to the change in events. Furthermore, the more dovish tones from central banks in New Zealand, Japan, and Europe encouraged foreign investors to seek higher returns in the U.S. because some international bonds were yielding less-than-zero.

Finally, the catalysts for volatility during the second quarter are the outcome of Brexit, the challenging U.S.-China trade negotiations and the slowing global economy. I’ve watched how the markets react to Brexit headlines and I don’t see much concern there. I think the worst has been priced in.

The actual announcement of a U.S.-China trade deal should be short-term bullish for stocks, but most of the deal has been priced into the markets. It’s the potential longer-term impact of the deal that will underpin stocks especially if we see throughout the year an improving global economy.