By Brian Herscovici, CFA
Chief Investment Officer, USAA Managed Portfolios
The Obama family was still learning their way around the White House, the Great Recession had a few more months to run, and the Philadelphia Phillies were preparing to defend their first World Series title in nearly three decades (spoiler alert: they didn’t) – this was all part of the American backdrop when the current bull market for stocks began on March 9, 2009.
At 10 years and counting, it is just a couple of months shy of being the longest bull market in U.S. history and a fruitful one as well – on a total-return basis, the Standard & Poor’s 500 Index has gained more than 300% since hitting bottom amid the wreckage of the financial crisis. And age doesn’t appear to be an issue: The 13.6% return in the first quarter of 2019 (Figure 2) was the best start to a year since 1998.
The bull hasn’t charged along on its own – it has had plenty of help from a Federal Reserve that held interest rates at essentially zero for seven years, along with massive stimulus in the form of fiscal spending (remember “Cash for Clunkers”?) and later large-scale tax cuts. And while several market events left it wheezing – the 2013 “taper tantrum” when the Fed first hinted at monetary tightening, the dollar-led tumble in oil prices in 2014-16, and last year’s panic about slowing global growth – the bull managed to stay on its feet.
Growth worries have carried over into 2019, with a string of weak data coming out of Europe and China in recent weeks. The U.S. is feeling the slowing trend, with GDP growth stepping down each quarter since mid-2018 as the impact of the 2017 tax cuts fades. The latest estimates from the New York Fed calls for 1.3% real growth in the first quarter of 2019.
Nervous investors have rushed into the Treasury market, pushing up bond prices and driving down yields for longer-maturity bonds. In late March, the Treasury yield curve inverted for the first time since 2007 – the 3-month Treasury bill offered a higher income return than a 10-year Treasury note.
A yield-curve inversion generates attention because one has preceded every U.S. recession in the past half-century, but the timing variations limit its predictive power for investors. The period between inversion and recession has ranged from less than a year to more than two years, with the average gap around 14 months.
While we look to be late in the business cycle, we don’t see a recession on the horizon. The Fed’s clear signal that it intends to pause interest rate increases in 2019 appears to be relieving some market anxiety – after the yield curve inverted in January 2006, the Fed hiked rates four times. The apparent progress toward a U.S.-China trade deal could also be a positive.
Global equity markets look to be at a crossroads.
One fork leads back toward the “there is no alternative to U.S. stocks” mindset that prevailed for much of this decade. GDP growth trends are worse overseas and other key U.S. data looks stronger –unemployment under 4% with modestly rising wages, job openings outnumbering job seekers (Figure 3), and inflation closer to target rates. The U.S. manufacturing sector continues to expand, consumers continue to spend, and we have less exposure to a struggling China than other developed markets.
The other fork goes to a place where overseas markets overcome their current economic malaise and unruly politics, and in doing so, their favorable valuations (Figure 4) once again attract investor attention and investor cash. China engineers a soft landing for its economy with the helping hand of government and perhaps a trade deal, and this stimulates animal spirits among its investors that lift other emerging markets as well. Europe and Japan also benefit from a more robust China through export growth. Stability returns to the European Union, as Brexit and Italy’s various crises get solved.
Current stock market behavior seems to be heavily driven by near-term positive sentiment for U.S. equities – volatility has dipped back into the docile zone last seen back in the fall, when the S&P 500 was at record levels.
But it’s important to remember that sentiment and volatility are prone to sharp swings, as we saw when stocks tanked at the end of 2018 and then fully rebounded in just a few weeks. No one knows where the market goes from here, but investors should be ready in case the ride turns out to be bumpy.
Tactical positioning in USAA Managed Portfolios at the end of the first quarter favored fixed income assets over equities to reflect our cautious stance given heightened market uncertainties, particularly those related to global economic growth.
We shifted away from tactical positions in U.S. large cap and international developed stocks during the quarter, but maintained our tactical allocation to U.S. small caps. We believe small caps can benefit from the relative strength of the U.S. economy while being less exposed to China-related trade turmoil.
Our key themes heading into the second quarter:
U.S. EQUITIES: With the fast start out of the blocks, U.S. stocks are riding a wave of positive momentum as we move into 2Q. And as discussed above, even with GDP growth slowing from 2018’s peppy pace, the U.S. outlook remains brighter than that of other major economies. And with the Fed on hold and talk of boosting fiscal spending, we could easily envision the current rally continuing deeper into 2019. That said, we will be closely focused on 1Q earnings to see if the forecast of negative year-over-year growth comes to pass – equity prices tend to follow earnings.
FIXED INCOME: We had been concerned in late 2018 about the rising risk of a Fed overshoot on rates and its impact on corporate debt, but the central bank’s decision to sit on its hands for a while has eased that concern. Slowing GDP growth, however, is still worrisome, as is the dour earnings growth outlook for U.S. equities. We leaned into high yield in January to take advantage of attractive prices available after December’s selloff, and in February we bumped up our Treasury stake based on our view that U.S. equities may have gotten overextended.
As always, our suggestion to members is to remain focused on the long-term investment plan that you have put so much thought into--be diversified and have a balanced portfolio that aligns with your risk tolerance. USAA Managed Portfolio shareholders who may be uneasy about market risk in general or have concerns about current asset-class allocations should consider consulting with a USAA advisor.
Investing in securities products involves risk, including possible loss of principal.
This material is provided for informational purposes only by USAA Asset Management Company (AMCO) and/or USAA Investment Management Company (IMCO), both registered investment advisors. The material is not investment advice and is not a recommendation, an offer, or a solicitation of an offer, to buy or sell any security, strategy or investment product. The views and opinions expressed in the material solely reflect the judgment of the authors, but not necessarily those of AMCO, IMCO or any affiliates as of the date provided and are subject to change at any time. All information and data presented herein has been obtained from sources believed to be reliable and is believed to be accurate as of the time presented, but AMCO/IMCO does not guarantee its accuracy. The information presented should not be regarded as a complete analysis of the subjects discussed. Any past results provided do not predict or indicate future performance, which may be negative. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of AMCO/IMCO and USAA.
Diversification is a technique to help reduce risk. There is no absolute guarantee that diversification will protect against a loss of income.
Past performance is no guarantee of future results.
Asset allocation does not protect against a loss or guarantee that an investor’s goal will be met.
USAA Managed Portfolios — UMP® (UMP) is an advisory service of USAA Investment Management Company (IMCO), a registered investment adviser, offered through its affiliate, USAA Financial Advisors, Inc. (FAI). Brokerage accounts are introduced and brokerage services provided by FAI and IMCO, both registered broker-dealers and Member SIPC. Clearing, custody and other services provided by National Financial Services LLC (NFS), Member NYSE and SIPC. A full description of the UMP program, including the investments, risks and applicable fees, is provided in the UMP Brochure. Information about UMP is also available by calling 1-800-531-1345.
Fixed income securities are subject to price volatility and a number of risks, including interest rate risk. Interest rates and bond prices move in opposite directions so that as interest rates rise, bond prices usually fall and vice versa. Interest rates are currently at historically low levels. Fixed income securities also carry other risks, such as inflation risk, liquidity risk, call risk, and credit and default risks. Lower-quality fixed income securities involve greater risk of default or price changes. Securities of non-U.S. issuers generally involve greater risks than U.S. investments and can decline significantly in response to adverse issuer, political, regulatory, market and economic risks. Fixed income securities sold or redeemed prior to maturity may be subject to loss.
Investments in foreign securities are subject to additional and more diverse risks, including but not limited to currency fluctuations, market illiquidity, and political and economic instability. Foreign investing may result in more rapid and extreme changes in value than investments made exclusively in the securities of U.S. companies. There may be less publicly available information relating to foreign companies than those in the U.S. Foreign securities may also be subject to foreign taxes. Investments made in emerging market countries may be particularly volatile. Economies of emerging market countries are generally less diverse and mature than more developed countries and may have less stable political systems.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The MSCI EAFE Index covers 21 developed markets outside of North America: Europe, Australasia and the Far East. It aims to include in its international indices 85% of the free float-adjusted market capitalization in each industry group within each country.
The MSCI USA Index is designed to measure the performance of the large- and mid-cap segments of the U.S. equity market. The index covers approximately 85% of the free float-adjusted market capitalization in the U.S.
The MSCI World ex USA Index measure large- and mid-cap stock performance in 22 developed markets (U.S. excluded). The index covers approximately 85% of the free float-adjusted market capitalization in each country.
The Bloomberg Barclays U.S. Municipal Index covers the U.S. dollar-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds.
The Bloomberg Barclays US Corporate High Yield Bond Index measures the U.S. dollar-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
The Standard & Poor’s 500 Index is an unmanaged index of 500 stocks representing the large cap segment of the market, covering 75% of the U.S. equities market.
The S&P SmallCap 600 Index measures the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.
The Russell 2000 Index is an unmanaged index that consists of the 2,000 smallest companies in the Russell 3000 Index. It is a widely recognized small cap index.
The Bloomberg Barclays U.S. Aggregate Bond Index is a widely recognized index used to track the performance of investment grade bonds in the U.S.
The Bloomberg Barclays U.S. Credit Index measures the performance of the investment-grade, taxable corporate and government-related bond market. It is composed of the Bloomberg Barclays U.S. Corporate Index and a non-corporate component that includes non-U.S. agency, sovereign, supranational and local authority bonds.
The JP Morgan Emerging Markets Bond Index Plus (EMBI+) tracks total returns for foreign currency-denominated, fixed-income securities issued in emerging markets.
USAA Wealth Management is a service of USAA. USAA means United Services Automobile Association and its affiliates.
Financial advice provided by USAA Financial Advisors, Inc. (FAI), a registered broker-dealer, USAA Investment Management Company (IMCO), a registered broker-dealer and investment adviser, and for insurance, USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License # OE36312). Investment products and services offered by IMCO and FAI.
Life insurance and annuities provided by USAA Life Insurance Co., San Antonio, TX, and in NY by USAA Life Insurance Co of New York, Highland Falls, NY. Other life and health insurance from select companies offered through USAA Life General Agency, Inc. (known in CA (license #0782231) and in NY as USAA Health and Life Insurance Agency).
Banking products offered by USAA Federal Savings Bank and USAA Savings Bank, both FDIC insured. Trust services provided by USAA Federal Savings Bank.
CFA™ and Chartered Financial Analyst™ are registered trademarks owned by CFA Institute. | ©2019 USAA.