After experiencing multi-year highs in the fourth quarter, equity markets “corrected”, pricing in a high probability of a recession and at least one Fed easing in 2019. Volatility returned to the market after a fourth Fed rate hike in December, ongoing international trade discussions, a moderation in global economic growth, and a change in Washington.
However, this scenario seems unrealistic given the true economic and market fundamentals provided in our quarterly market overview. Amid the equity market correction and extreme widening of corporate risk premiums, the US economic fundamentals continue to impress with strong growth in employment, wages, consumption and investment.
Bonds had slightly positive returns in Q4 as investors sought safe haven assets, driving interest rates lower. The flight to quality drove high quality bonds such as Treasury and Mortgage Backed Securities back to positive returns for the year, while the widening in risk premiums pushed corporate bonds negative.
Going forward, strong employment and income together with lower taxes, stronger corporate investment and earnings may enable the economy and equity markets to withstand a higher interest rate environment. The recent drop in Oil prices may provide an economic stimulus via lower gas prices and input costs. Higher interest rates, trade agreements, Government shutdown, and geopolitical risks have increased market volatility but are likely to normalize as resolutions become clear.