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By Brian Herscovici, CFA

Chief Investment Officer, USAA Managed Portfolios








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  • A stock recovery that started just after Christmas was a gift that kept on giving in the first quarter, with free delivery provided by the newly patient policymakers at the Federal Reserve. U.S. large caps and small caps got off to their fastest start in years despite a bleak outlook for earnings growth in the first quarter. Overseas equities shared in the bounty.


  • In late March, the Treasury yield curve inverted for the first time since 2007, and in doing so, instantly made recession risk a front-of-mind issue for many investors. On the other hand, strong stock returns helped ease the perceived risks for corporate bonds during the quarter.




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.


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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.


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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.


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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.


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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.

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