The U.S. stock market has bolted out of the starting gates this year like a three year- old thoroughbred colt at the start of the Kentucky Derby. Following the pathetic effort by stocks to close out the 2018 year, the eager jump in stock valuations has been a welcome relief. However, the question we all express verbally or silently is “How long will it last?”. Before we provide an answer, let’s look at a few other indicators that can help shed some insight to the question’s resolution.
Economic growth is always a crucial part to the longevity of stock market runs. We estimated that U.S. growth (as measured by Gross Domestic Product GDP) would grow this year by 2.8%. The GDP growth rate for 2018 was 2.9%; so, our 2019 forecast does not anticipate much of a slowdown this year. The first quarter will have some headwinds that should dissipate throughout the year – the government shutdown in the first quarter will hopefully not be repeated this year, uncertainty about the Federal Reserve’s actions regarding interest rates have largely been removed and it seems the U.S. and China may be reaching a point where they can agree on a new trade agreement. While there has certainly been a softening in growth during the first quarter of this year, we believe the economy will rebound and get stronger as the year progresses. It may be that our growth estimate is too high; however, we still expect growth of 2.5% or better for the year. We believe consumers will still be willing to spend money on purchases and that businesses will feel more comfortable investing in their own infrastructure as they sense growth opportunities in front of them.
We have been surprised at how low interest rates have fallen so far this year. By the end of the first quarter, the 10 -year U.S. Treasury Note yield had declined to the 2.4% area – just last August, the yield pushed over 3.4%. The decline from 3.4% to 2.4% is a huge move in a mere seven months. Uncertainty and confusion regarding the U.K.’s efforts to leave the European Union (EU) and a slower than expected growth rate in Europe and the rest of the world added to the impetus for interest rates to move lower. The Federal Reserve’s announcement to hold off raising rates for the rest of 2019 provided the final catalyst to throw caution to the wind and send interest rates lower.
It is often difficult to be objective when our forecast and actuality are not moving in the same direction; as is the case with the current level of interest rates. We estimated that the 10- year UST yield would approach 3.35% by year end. Our thesis was built upon the idea that U.S. economic growth would remain steady and in a positive direction, while inflation from wages, energy and food costs would increase. With the unemployment rate at 3.8% and energy prices moving higher, we may yet see some inflation push that will lead interest rates higher than their current yield of 2.52% by year end.
To complete our look for additional insights to how long this strong move in stocks and bonds can last, we need to also include some thought regarding the rest of the world’s economic status. The EU feels to us like economic activity is stifled for the time being by Brexit and social unrest. We don’t anticipate a great deal of help from the EU in moving world growth forward. China is beginning to act like it may be putting in a base and perhaps bottoming out in its growth movement – that implies a 5% or higher rate of growth this year. In a general catch all, we expect developing international markets to perform better than the developed markets outside of the U.S.; but, anticipate the U.S. to again be the star performer.
Back to the question we began with – “How long will it last?”. We think the U.S. stock market will be higher by year end than it currently is if interest rates as measured by the U.S. 10-year yield are lower than 3.0%. We think the Federal Reserve Board will be reluctant to move interest rates higher until there is clear evidence in their minds that inflation is not only above 2.0%; but, on a course to a higher level unless the economic brakes are tapped. So, while not in a straight line up, we expect stocks to move higher while believing that we have seen the low in interest rate yields for the year.
Changes at Cannon Capital Management
We have been blessed to have Lori Anderson work with us for the past year. Lori has made each of us at Cannon Capital a better person by her consistent cheerfulness and kindness. Those of you who have had an opportunity to interact with Lori will surely agree with our assessment of Lori and her contributions. However, Lori and Larry, her husband, can retire from the professional work place sooner than anticipated and they are jumping in with both feet. We will miss Lori and wish her and Larry all the success, health and happiness in this new adventure of their lives.
We are pleased to announce that SueAnn Abeyta has joined us and will be working closely with Carolyn at Cannon Capital. SueAnn has an infectious happiness about her and brings great personal interaction skills along with a keen technology background and desire to “do it right” – she is a great fit in our effort to Make Life Better. SueAnn will be joining us initially on a part-time basis. You will no doubt enjoy her cheerful personality and desire to help as you become acquainted with her.
Enjoy the warmer spring weather – whenever it shows up. Thank you for the opportunity to work with you!