A wave of optimism ushered in the New Year, with equities and credit rallying strongly across the world. The S&P 500 on Friday closed out its best quarter in nearly a decade, having jumped 13.1% through the first three months of 2019. And, many other investments, from junk bonds to foreign stocks, have also bounced back from the dismal end to 2018. Amazingly, despite the rally, the major indices are still below the levels seen at the start of Q4 2018. The sell-off in equities and credit in the final quarter of last year was caused predominantly by concerns about the potential for an escalation in the trade war between the U.S. and China; fears that higher interest rates could hurt the U.S. economy, and broader worries about a slowdown in global growth, especially here in the U.S.

In many ways, the weakness in Q4 2018 set the stage for the recovery in equity markets this quarter. The Federal Reserve (Fed) reacted to the market weakness, and weaker global growth, by changing its language, reflecting more patience. Much of the rally this year has been built on market expectations that the Fed will not be raising interest rates again anytime soon. In fact, the next move expected from the Fed by the bond market is now a cut, with 10-year Treasury yields down to 2.4%. The sharp fall in the U.S. stock market late last year was probably also a factor in deterring the U.S. administration from further increasing tariffs on China over the quarter. In other words, the stock market decline of last year helped to reduce two of the major risks that had caused it in the first place.

For the recovery in markets to continue throughout this year, the weakness in global growth will also have to recede, extending what has already been a very long economic expansion by historical standards. So far, economic growth in the U.S. remains on firm footing, based on our forward-looking economic indicators. In that context, for now we would view any sell-off more as a healthy retrenchment than being indicative of the start of a long, drawn-out bear market.

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