“I claim not to have controlled events, but confess plainly that events have controlled me.” Abraham Lincoln in a letter to Albert Hodges, April 4, 1864.
What a difference three months makes. As 2019 began investors were coming to grips with the worst quarterly performance in U.S. equity markets since the third quarter of 2011. Despite the dramatic fourth quarter contraction in equity markets, Fed Chairman Jerome Powell initially indicated that the Fed’s unwinding of its balance sheet would continue on “automatic pilot.” Based on the Chairman Powell’s statement the bond market continued to price in two more rate hikes in 2019.
We noted in our Fourth Quarter 2018 Commentary, however, in contrast to the pessimism dominating market sentiment there were still some fundamentally encouraging factors investors needed to keep in mind, chief among them an economic environment featuring low inflation and low unemployment, and equity markets trading at much more attractive valuations. We also noted in the closing paragraph that investors needed to continue to focus on their long-term investment plan and the “investment plan should include contingencies for changing market conditions.”
It didn’t take very long at all for market conditions to change. Stocks and other risky assets rebounded dramatically in the first quarter. U.S. markets again led the way. U.S. large cap stocks (the S&P 500) and small cap stocks (Russell 2000) were up 13.65% and 14.58% respectively. Broad foreign market indices just missed being up double digits in the first quarter, with the MSCI-EAFE Index posting a return of 9.98% and the MSCI Emerging Markets Index up 9.92%. As has been the case for much of the last decade, growth stocks outperformed value stocks in the first quarter, and the best performing sector in the quarter was Technology, up 19.9%.
While equity markets were rallying, so were bond markets, particularly intermediate- and long-term bonds. The Bloomberg Barclays U.S. Aggregate Bond Index returned 2.94% in the quarter. This bond market rally began in late 2018 when the benchmark 10-Year U.S. Treasury peaked at a yield of 3.24% on November 8. By the end of the first quarter the 10-Year Treasury fell all the way to 2.41%, below the yield of both the 2-Month and the 6-Month Treasury Bills, which both ended the quarter yielding 2.44%. This inversion of the yield curve has added to growing concerns of a slowdown in economic growth. Other indicators seem to add to the growing chorus fears of slowing economic growth, which include fears over the impact of a hard Brexit (the U.K. exit from the European Union), concerns over trade wars, and slowing growth in China. With all of that as a background, in the Fed’s March 20th post-meeting statement, Fed Chairman Jerome Powell said that the Fed was now in a “pause period,” and most observers are pricing in no rate cuts throughout the rest of 2019.
So, in short three months, much has changed. Outside events, or “exogenous shocks” in the language of professional economists, are something for which we should always be prepared. Indeed, as our 16th President noted, we are rarely, if ever, able to control outside events and most often find ourselves controlled by these same events. The key tools that investors have in dealing with unexpected events include a well-thought-out long-term investment plan, a disciplined approach to executing the plan, the fortitude to stick to the plan, and the flexibility to take advantage of opportunities as they arise.