March 2019

Grass growing inside of a pothole on the road

“Hesitation increases in relation to risk in equal proportion to age.”

Ernest Hemingway

Mr. Hemingway’s words were offered with different context; however, they apply to today’s investment environment. Investor hesitation is understandable today with elevated uncertainty risks and an aging recovery. The challenge with any pothole is to cautiously navigate through it rather than swerve creating a bigger hazard. The opportunity is to get through it to a smoother ride on the other side.

The recent dovish tone from the Fed along with stimulus measures from China support equity markets, but it’s too early for results and potholes remain. The Fed, trade, Washington, recession fears, volatility, yield curve, earnings and currencies are some of the potholes that could cause a bumpy ride or perhaps opportunity in 2019. These can be successfully navigated while searching for green shoots of growth for future opportunities.

The Fed and Economy:

The Fed has hit the pause button for future rate hikes in 2019 while continuing to trim its balance sheet. We view current policy as accommodative but would stop short of calling it easy. Their full employment mandate is a mission accomplished. Inflation hovers near the Fed’s +/- 2% target rate but, behind closed doors, they are equally concerned with avoiding deflation given recent weak data. The Fed wants to avoid outright deflation at all costs as that would shift the U.S. economy from its current stall speed into recession.

The chart below provides a snapshot how stocks, government bonds and corporate bonds have historically performed in alternative inflationary/deflationary environments. It’s dangerous to simply extrapolate historic data and make a forecast, but it’s interesting to note our current stable price environment has been the friendliest for stocks.

Chart of Asset Returns under Different Inflation Scenarios during from 1926-2018

Takeaway: First quarter GDP is historically the lowest of the year. In our February edition we said: “First quarter 2019 may feel like a soft landing due to the government shutdown but is likely to be transitory as 2019 progresses.” Atlanta and New York Fed forecasts for 0.4% and 1.4% Q1 growth support our case for a Q1 soft landing. We think growth will pick up in the second quarter back toward a trend rate closer to 2%.


Our more detailed thoughts on trade policy are in our Feb. 20th edition of Market Spotlight that was dedicated to trade policy. The link is here:

In summary, our outlook concluded:

  • President Trump would extend the previous March 1 tariff deadline
  • A truce would not necessarily be an economic tailwind but would remove a market headwind of uncertainty
  • A failed deal or unexpected delay could cause markets to retest support levels for U.S. stocks
  • A deal will likely conclude with a personal meeting between Trump and XI within 60 days

Update: Since that article was written, additional data has continued to support our conclusions specifically about business confidence. Tariffs are resulting in a larger economic drag on China and the rest of the world than the U.S. However, the downturn in CEO confidence (red line) shown below suggests weak confidence often leads to a drag on capital expenditures and investing.

Chart of Real Prive Nonresidential Fixed Investment versus CEO Outlook Survery

Takeaway: Consumers continue to prop up the U.S. economy, but a trade resolution would generate renewed CEO confidence and stronger growth in the second half of the year.

Washington and Political Uncertainty:

While nothing has ever been “certain” about Washington politics, current uncertainty and polarity in Washington is elevated. A primary market issue in 2019 will be the debt ceiling debate this fall. A best case (but unlikely) scenario would be a conciliatory tone from both parties in the interest of getting something done. A worst case scenario would be a repeat of 2011, which led to the sequester and downgrade of U.S. debt by Standard & Poor’s on Aug. 2, 2011. This is a risk markets have conveniently ignored so far.

chart of S&P 500 returns following spikes in global policy uncertainty

Takeaway: Sources of policy uncertainty take many forms. They don’t necessarily emanate from Washington. The chart above from our friends at Strategas reveals that after spikes in policy uncertainty, markets often bounce back once emotion subsides. This suggests many daily headlines have little economic staying power, a good thing.

Recession and Non-Recession Corrections:

What we experienced during Q4 last year was a cyclical bear market outside of a recession. The chart below offers some history around previous corrections (down between -10% and -20%) and bear markets (down over -20%).

Chart of Post World War 2 Bear Markets and Corrections Recessions versus non-Recessions

There are key differences:

  • Bear markets (red) and corrections (orange) within a recession are longer lasting and more severe
  • Recessions experience more bear markets than corrections
  • Non-recessions experience more corrections than bear markets

So why do we bring this up? Each quarter we host our live Market Talk client event. Clients who register are given the opportunity to submit questions on issues important to them. Lately, questions surrounding corrections and recessions have been the dominant theme, so we thought we would address it here as well.

Takeaway: Recession risks are currently higher abroad than in the U.S. We have increased our subjective odds of a U.S. recession in 2019 from 5% to 10%. Those risks rise further into 2020 and 2021. Key indicators we watch include:

  • An inverted yield curve
  • Year-over-year decline in Leading Economic Indicators index (LEI)
  • Restrictive monetary policy
  • The employment 4X4 (Sub 4% unemployment with 4% or more wage growth)
  • Earnings recession

These are most reliable when all signals flash caution together. Currently, all have weakened but none have flashed red. Stock market returns typically do well from six to 18 months before a recession, but struggle six months prior to the onset of recession. In short, growth has slowed but recession risks remain muted. We will update our outlook here for any changes but until then, conditions favor stocks over bonds with low recession risks in 2019.

Volatility, the Old Normal:

Last year played out as we said in our 2018 Outlook shifting from 2017’s high return/low risk regime to a lower return/higher risk regime. The chart below shows the number of days the S&P 500 moved by more than +/-: 1%, 2%, 3%, 4% and 5%. Furthermore, it shows the number of days markets experienced those price swings (up and down) for 2017 (orange), 2018 (red) and on average (grey) since WW2. The similarity between 2018 and the long-term average was uncanny.

Number of S&P 500 Daily % Price Changes

Takeaway: Volatility is a two-way street and after 2018, investors should come to expect future volatility to approximate past volatility. That is a normal condition of markets that is here to stay.

The Yield Curve:

Earlier in our discussion about recession indicators we mentioned an inverted yield curve has a better-than-average (not perfect) record foreshadowing recession. In fact, since WW2 when an inverted yield curve occurred prior to a recession, it did so by roughly 14 months. The current yield curve is flat reflecting very small differences between short- and long-term bond yields. This is typical during periods of weak economic growth. Inverted yield curves happen when short rates exceed long rates, often occurring before recessions. Consider the chart below:

Chart of 10 Year Treasury Curve Flattening from March 13th 2018 to March 13th 2019

The orange line above reflects that one year ago, long-term bonds carried higher yields than short-term bonds. The red line is where we are today with interest rates nearly equal for all maturities.

Takeaway: The yield curve can remain flat for an extended period of time like it did in 1998. Even if it inverted, that typically leads a recession by 14 months and does not imply imminent market risk. The caution light is yellow but not flashing red.


Stocks soared in 2017 as they anticipated a rising 2018 earnings windfall from corporate tax reform. Stocks declined in 2018 as markets anticipated waning 2019 earnings as the impact from tax-reform faded.

  • Q1 earnings estimates have been consistently reduced since the beginning of the year. S&P 500 earnings growth rates for calendar 2019 have been reduced since the beginning of the year from 7.3% to 3.9%. As the chart below shows, Q1 earnings for the S&P 500 are anticipated to decline 3.4%, but what is even more telling is when you split S&P 500 companies into two categories.
  • Those who get more than 50% of their revenue from the U.S.
  • Those who get more than 50% of revenue from outside the U.S.

S&P 500 Estimated Q1 2019 Earnings and Sales Growth

Takeaway: Companies generating most of their business in the U.S. are expected to grow earnings just 1% this quarter whereas those doing most of their business abroad are expected to decline roughly 11%. Our hope is these estimates are overly pessimistic and subject to upward revisions if trade uncertainties are lifted. They reflect two recurring themes:

  • Multinational firms generating most of their business from foreign sources are disproportionately impacted from tariffs, weak growth abroad or both.
  • A strong dollar has impacted multinational firms as they are converting weaker foreign currency revenues into stronger U.S. dollars.

Currency Impact on International Stocks:

International investing is a two-part decision for U.S. investors.

  • What markets do you want to invest in?
  • What currency do you want to hold?

The chart below is a good illustration of the impact currencies can have during years when the dollar goes down (2017) and when the dollar goes up (2018). The grey bar reveals the dollar impact on total returns to U.S. investors.

Chart of International Equity Returns and MSCI All-Country World-excluding USA

Takeaway: Global equity benchmarks have roughly 50% in U.S. stocks and 50% in international stocks. To reduce the risk of investing internationally due to currency fluctuation, our strategies typically limit the amount of international stocks to allocations that are significantly below typical benchmarks.

Final Thoughts:

  • Q1 weakness should yield to seasonally stronger Q2
  • Fed to remain on hold indefinitely
  • Easier Fed, China and ECB policy remains positive for stocks but it is too early for results
  • Stocks are range bound in search of a catalyst
  • A spring trade resolution and a weaker dollar are potential catalysts
  • Deteriorating growth, a failed trade deal and a budget impasse are prominent risks
  • Interest rates to remain in a flat yield curve environment for much of 2019
  • U.S. recession risks remain low
  • Volatility has returned to its long-run normal range
  • Dollar weakness in the second half of the year could aid international returns

Thank you and please reach out to your BB&T Portfolio Manager or Wealth Advisor with any questions.

Jeff Terrell, CFA Chief Wealth Market Strategist
BB&T Wealth Portfolio Management Team

Sources: Strategas Research Partners, Evercore ISI, FactSet, Goldman Sachs Global Investment Research, Morningstar, BCA Research, Standard & Poors

The information set forth herein was obtained from sources, which we believe reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Diversifying investments does not ensure against market loss and asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Past performance does not guarantee future results.