Morningstar Cloud Quarterly Market Commentary: First Quarter Trends in 14 Charts
By Tom Lauricella and Gabrielle Dibenedetto | Apr 01 2019
Global equity markets staged a significant rebound in the first quarter, reversing the steep U.S.-led fourth-quarter sell-off, as major central banks backed away from pursuing tighter monetary policy.
After the bruising taken by investors in the fourth quarter, the first-quarter rally was likely a welcome relief for stock investors. However, all is not well according to the bond markets.
Interest rate trends during the first quarter suggested that the catalyst for those central bank policy shifts–a stumbling global economy–may prove to be a double-edged sword for investors. In fact, the same signs of slowing growth that led the Federal Reserve and European Central Bank to take their foot off the brake were accompanied by a signal from the U.S. bond market that the odds of a recession in the United States are climbing.
Still, the first quarter marked a significant bounce for the equity markets. Heading into 2019, global equity markets were on the ropes, with many major indexes suffering their largest quarterly declines since the financial crisis a decade ago amid concerns about the global economy, particularly the impact of trade frictions with the U.S. government.
Looking at the first-quarter stock rallies move in isolation, it might appear that investors saw a renewed open road ahead for the long bull market. The broad Morningstar U.S. Market Index rose 14.1% on a total return basis, its strongest quarterly rise since the financial crisis.
For the S&P 500, the first quarter was marked by a strong move higher through the middle of February, after which the index largely treaded water. (Click on images for better viewing)
The gains were broad-based among U.S. stocks, with growth categories generally leading the charge.
It was also a sea of green elsewhere around the globe, as seen in the Morningstar Global Market Barometer.
However, stepping back to look at the past 12 months of market performance tells a very different story for the quarter for the S&P 500. The extent to which the first-quarter rally was a round trip of the fourth-quarter sell-off becomes clear.
Despite the strong move higher in stocks, by early March much of the attention had shifted to the U.S. Treasury market. For much of 2018, the story in the bond market was rising interest rates and a steady flattening of the yield curve as the Fed tightened monetary policy.
The bond market captured the headlines in March when, amid signs of a slowing U.S. economy, the yield on the 10-year Treasury fell below that of the three-month bill. Such an inverted yield curve has historically been one of the most accurate predictors of a recession, although the lead time from the inversion to the onset of an economic downturn has varied significantly. Still, the sight of the yield-curve inversion was enough to attract attention.
The decline in longer-term bond yields wasn’t confined to the United States, as economic growth has slowed significantly in Europe as well. In the fourth quarter, Germany’s economy narrowly avoided falling into recession. Now, eight years after the eurozone crisis came to a boil, European bond investors are again confronted with negative bond yields in Germany, and the political turmoil around Brexit has cast a large shadow over the economic prospects for the U.K. economy.
Against this backdrop, interest-rate-sensitive long-term bonds were the best performers. However, the combination of the stock-market rally and the fixed-income rally combined to also produce solid returns on corporate bonds.
In the commodities markets, the global growth scare sent oil prices tumbling in 2018. But the easier-money stances by the Fed and ECB, along with announced production cuts by OPEC, led to a sharp rebound. Copper and gold prices also got a boost from the changed monetary policy outlook.
Turning back to the details of the equity market, mid- and small-cap stocks were the leaders, likely reflecting the Fed’s assurances on monetary policy, which is generally seen as benefiting more U.S.-focused stocks found in the mid- and small-cap indexes. The largest weighted stock in the Morningstar U.S. Small Cap Index at quarter end, The Trade Desk (TTD), surged 70.6% in the first quarter following a 23.1% loss in the fourth quarter.
As has been the case for some time, growth stocks led the charge. Within the Morningstar Mid Growth Index, Workday (WDAY) gained 33.6% to start 2019 after a 43.4% drop in the fourth quarter.
Large value was once again among the quarterly laggards.
Looking over longer time frames, the growth/value gap remains wide, led by such names as Microsoft (MSFT), Amazon.com (AMZN), Facebook (FB), and Visa V.
Among stock sectors this quarter, technology names led among U.S. equities. In the fourth quarter, tech stocks were the second-worst performer with an 18% loss. Xerox (XRX) was the biggest winner in the tech sector at the beginning of 2019, gaining 63% following strong fourth-quarter results and an ongoing restructuring effort. Industrials was paced by a 34.1% rise in General Electric (GE) as new leadership came on board the struggling conglomerate.
Defensive sectors unsurprisingly lagged the strong first-quarter rally. But over the past year, utilities have been the best-performing category, helped by a combination of a flight for safety at the end of 2018 and an improved interest-rate environment.
Viewed through the lens of the Morningstar Economic Moat Rating framework, we see a change in leadership in the first quarter. The Morningstar Wide Moat index has been far ahead over the past 12 months, led by gains in top-weighting stocks such as Amazon, Procter & Gamble (PG), MasterCard (MA), Visa, and Microsoft. In the first quarter, however, Morningstar’s Narrow Moat Index outperformed, helped by a 34.6% gain in NVIDIA (NVDA) and a 33.2% rise in Netflix (NFLX).
The Morningstar Target Momentum Index, which includes U.S. companies that display above-average return on equity, with added emphasis on upward revisions of fiscal earnings estimates and technical price momentum indicators, was the leader in the first quarter, led by Paycom Software (PAYC) and Xilinx (XLNX), which clocked in returns of 54.5% and 49.3%, respectively. It also included Boeing (BA), with a 18.9% return despite groundings of the 737 MAX that contributed to a 13.3% drop in March.
Overall, the rallies have erased many of the opportunities to be had in the stock market based on Morningstar’s valuation rankings. Morningstar’s valuation framework finds that global equities are now only slightly undervalued.
For more on which sectors and individual stocks Morningstar’s equity analysts believe are attractive, see our second-quarter outlook, available here. An explanation of the equity ratings methodology can be found here.