By Don Schreiber, Jr. – WBI Founder and CEO
U.S. markets experienced a blood bath on Friday with the market-leading large caps down -1.89%, using the S&P 500 Index as a guideline. Looking at the exchange-traded funds (ETFs) that track popular large-cap indexes tells the same story with iShares Russell 1000 Value ETF (ticker: IWD) falling by -1.78% and iShares Russell 1000 Growth ETF (ticker: IWF) posting a drop of -2.17%. Large-cap damage was muted when compared to small and mid-cap stocks with the iShares Russell 2000 ETF (ticker: IWM) giving up -3.65%. The iShares Russell 2000 Growth ETF (ticker: IWO) slide even trumped those, losing -4.03%.
This strong reversal in price momentum should be viewed in context with the Federal Reserve’s surprisingly dovish statements on Wednesday at the conclusion of their meeting. The Fed became more accommodative than expected by reducing rate hike expectations for 2019 to zero. They also indicated they would be winding down their quantitative tightening balance sheet reduction program by September this year. Unfortunately, they also marked down growth expectations for the economy and inflation, confirming the weakening trend for the U.S. economy and markets. Immediately after the announcement, the markets rallied only to give back the gain late in the day to end mostly unchanged. Thursday’s positive market move turned out to be a head fake that led to Friday’s carnage.
The other big driver, hope for a near term trade deal with China, was widely supported by the Trump administration and Chinese news releases. The President was vocal in support of economic growth and a positive market trend during the week. With both the Fed and White House supporting economic growth and positive market trends, it is somewhat alarming that markets are now trending negative.
According to John Butters from FactSet, 105 companies have issued earnings guidance for Q1 with 77 issuing negative guidance, and only 28 have issued positive guidance. This negative guidance trend is higher than usual and has led to negative analyst sentiment causing them to mark down estimates which now indicate S&P 500 companies are likely to post negative growth for Q1. You would expect stock prices to fall against negative corporate trends and this may explain investors’ flight from equities on Friday.
GDP growth drives corporate earnings and revenue growth, so it is interesting the Fed only marked down 2019 GDP growth from 2.3% to 2.1% and their 2020 forecast to 1.9% from 2.0%. With these modest reductions, it is hard to reconcile a full stop on interest rate hikes. In the post-meeting press roundup Fed Chair Jerome Powell did note weaker incoming data but was still upbeat on growth for the U.S. With negative trending economic data coming out of Europe, Japan, and China, the risk of a global recession seems imminent. Add to that a yield curve inversion in the 3-year and 10-year treasury rates which has had a strong record of preceding a recession and Friday’s market move becomes pretty clear.
It is too early to call an end to the economic expansion and ten-year bull market. Unfortunately, we need to confirm a recession with two-quarters of GDP contraction and a deeper bear trend would require a -20% drop from recent highs and hand investors bigger losses. However, it’s not too early for investors to trim risk positions by reducing equity exposure domestically and across the pond. It would also be prudent to book some profits on emerging market positions that have had a strong recovery as investors committed larger allocations to these regions. Stay tuned, the next couple of quarters are likely to be lively and quite interesting.
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Index Return data provided by ishares.com as of 3/22/2019.