Welcome to the Bryn Mawr Trust Wealth Management podcast, providing commentary on what’s moving the financial markets, financial planning, and other timely business and monetary topics. Please welcome today’s host, Ernie Cecilia– chief investment officer for BMT Wealth Management.
[ERNIE CECILIA] Hi, this is Ernie Cecilia– chief investment officer of the Bryn Mawr Trust Wealth division, here to spend a few minutes with you. And what I plan to do in this brief time with you is to look back briefly, at the fourth quarter of 2018. Talk about the recently completed first quarter of 2019. And then perhaps, most importantly, take a brief look ahead as to what is going on in the financial markets, and how that affects our investments.
Let me start off by talking a little bit about the fact that economic growth has been slowing on a global basis. That has been a concern, particularly since this is, very much, a global economy, very connected. And to the extent that weakness abroad affects the US– that is a concern for the markets.
And we’ve seen weakness in some of the reporting, certainly the reporting out of Japan and the manufacturing sector. Certainly China, which is in the news for trade and tariffs. We’ve seen consumer demand weaken in China. We’ve also seen lower forecasts for growth in China. And also, Europe. The European Central Bank lowered its forecast for 2019 GDP growth, and that’s of concern.
And even earlier this morning– April 10– the International Monetary Fund lowered its global growth forecast to 3.3% from 3.5%. And it cited concerns about trade policy uncertainty and that affecting inventory investments, supply chain management, and productivity growth. So if you take that in total and you think about how that would affect the US– and we know recently that the Federal Reserve came out and lowered their growth projections for 2019, 2020, and 2021– and growths somewhere just about 2% or slightly under. And that’s coming off a 3% growth rate in 2018.
That said, we’ve seen some more recent numbers which suggests, perhaps, the first quarter– which recently completed– and looking at Atlanta Fed projections may come in, it’s somewhere around 2.1% or 2.2%. And that’s up rather significantly. We had strong March employment data. Nice rebound in new jobs– 196,000 new jobs.
So that’s kind of what we’re facing right now. And it might be that some of the weakness that was considered to be pervasive in the US might be slightly overstated. But yet, that is to be determined.
So the question is, how does that affect the Federal Reserve and their announcements back on March 20th? And they decided– as I think we know well– to keep short-term interest rates, their target– what’s called their target fed funds rate– in the area of 2.25% to 2.5%. And they expressed concerns regarding some recent weakness in US economic data, as well as more profound weakness in some of the international markets that I just mentioned.
Following its announcement, markets– particularly the equity markets– rallied. But then, perhaps a little sobriety came in as the yield curve inverted– that is short-term rates were higher than longer term rates, which often portends weakness ahead. And then after a brief sell-off, a couple days after the Fed announcement– the markets continued to rally through the end of the first quarter are doing pretty well as we are now approaching the first third of the month of April.
So with that said, our main view is that with the Fed– in our view, on hold pretty much from a rate perspective– that’s been a positive for equity markets. And so if we think about what happened in the fourth quarter of 2018– in our view– it had a lot to do with the fact that the Fed and perhaps pick the equity markets thinking that the Fed was too aggressive in terms of their monetary policy. That is aggressive in terms of tightening– keeping rates low and unwinding their balance sheet.
Interestingly enough, it appears that the bond market, perhaps, was a little bit more forward-looking. And that is the bond market– or it should say, rates on the longer part of the yield curve– actually were declining. And oftentimes– and this is a good message– is that when you look at the bond market, gives you some information about what might be happening or what should be happening in the equity markets.
That said, as we approached the end of the fourth quarter of last year and the markets were correcting rather dramatically, it became somewhat apparent– particularly after the sell-off in December– that the Fed might be taking an easier stance. And indeed, that happened.
So the narrative changed, and the Fed changed– if you will– in January and became more dovish– that is more friendly in terms of not raising rates, less aggressive in terms of monetary policy. And stocks responded rather quickly to the change. And as we know, the first quarter was rather strong in terms of equity performance across all the markets, both domestically as well as internationally.
So the question might be, now that we’ve had recovery to a large extent in a lot of the markets– what are some of the areas of the markets that might be attractive when we break it down a little further? So within the equity markets, we know that the decline in interest rates and the inversion in some parts of the yield curve– which I just mentioned– present challenges to financial companies, particularly banks. However, we do think that a lot of this uncertainty or negativity– if you will– has been reflected in the valuations, particularly in banks. So on a selective basis, we believe that there are opportunities in this group.
The second area which was under pressure, particularly as the issue of global slowdown came to fore, was the industrial space or the industrial sector. And we think, in many cases, some of these stocks of some of these companies have been overly penalized in terms of their stock price and valuation.
Here, too, we’re finding companies where the valuations seem to be disconnected to some of the long-term fundamentals. In fact, industrials were one of the better performing sectors coming out of the first quarter of this year.
And then, finally, the information technology sector– which is a group that continues to benefit from a move in the economy going forward– we think there are some opportunities there on a very selective basis. I would say, however, that we are very conscious of valuation. The information technology sector did well as a sector in the first quarter, but the differences within the sector in terms of performance was rather significant.
So let’s put that together. And most importantly, what does that mean as we take a look going forward? Well, first of all– and I started talking about economic growth and some of the concerns, both globally and domestically– economic growth impacts both corporate earnings and interest rates significantly. And in turn, equity valuations.
So if I was able to show you a graph that showed the correlation between earnings and price- — let’s just say, it’s a very high correlation. So in other words, earnings matter. So that’s an issue.
So as now we’re into the earlier part of April, we’re going to start getting earnings reports from companies from the first quarter of this year. And this will be, most likely, the first quarter where we’ll see– at least on a projected basis– the first quarter where we’re going to see negative year over year earnings comparisons since 2016.
So it’s going to be a little bit of a challenge in terms of earnings, but we think that the market is somewhat thinking in that way. And if anything, perhaps– hopefully, maybe this is hopeful thinking– some of the downward revisions will be less severe than thought. I mentioned the fact that we briefly had a yield curve inversion. And oftentimes, when you have a yield curve inversion, returns on equities when you look out– particularly a year so– tend to be more subdued.
And that fits really with our long-term thinking, in that we think larger cap domestic equities may return somewhere in the mid-single digits with faster or higher growth. Maybe better returns. And some of the small and mid-cap sectors is also in some of the emerging markets around the world. I will point out, however, in those other assets– sub equity asset classes– that the issue of volatility will be more severe than if you will, in some of the large cap areas of the market.
So again, let’s place into context– what does this mean? In terms of equities, we think there could be a good amount of volatility as some of the projections, growth projections become more uneven and less predictable. We think that some of the activity that we saw in the bond market, perhaps, is overdone. And that we could see some reversal– that is some rise in rates as the year progresses.
With that mind, however, it’s really important– we’ve been very cognizant in managing maturity or duration risk. And also we’re very conscious of credit in a market where, again, we have an economic expansion that’ll hit 10 years this June. So it’s rather long in the tooth– so to speak.
So again, we have a long cycle– 10 years in June. We have growth projections that become a little bit more uneven, less predictable. And with volatility accelerating, we are of the view that it’s really important to revisit asset allocation. Take a look at risk profiles, and understand where we are in the stage of the cycle. We think there are absolutely gains to be had, to be achieved. But perhaps, that the risk in achieving those gains are a little higher.
So taking a look for the client at the client level. We’re spending a lot of time speaking with our clients about asset allocation. And determining risk. And by risk, I’m talking about volatility going forward.
So again, it was a pleasure spending a few minutes with you. And we certainly look forward to speaking with our clients. And that is also handling any other inquiries going forward. Thank you so much, and have a great day.
[CONCLUSION/CLOSE] This has been a production of Bryn Mawr Trust, copyright 2019. Visit us online at BMT.com/wealth.
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