Source: (T) Bloomberg. (L) Macrobond. (R) Macrobond.
In Q2, we expect stock markets to continue careening between tailwinds and headwinds, and for volatility to be the prevailing theme. After experiencing nearly two years of stellar returns and record-low volatility, investors received a harsh reminder that volatility can quickly boil over. In Q4 the S&P 500 fell 13.5%, its worst quarter since 2011, only to be followed in 2019 by its best Q1 since 1991.
Buybacks have been a key driver of equity returns over the past few years, as cash-rich companies have decided to return money to stockholders in order to lift share prices. In 2018, S&P 500 companies bought back more than $800 billion in shares, representing approximately 3.4% of the current index market cap. This trend, along with a dovish pivot by the Fed that has markets pricing in a probability of a rate cut, is likely to continue adding support to equities as we move further into 2019.
While these more technical factors should be positive for valuations, structural issues stand to put pressure on returns going forward. Corporate profits, while still strong, look to have peaked and now enter a familiar late-cycle pattern. As a tight labor market has finally started to boost wage gains, we look for increased cost of labor to eat into operating results going forward. Global growth concerns have also hampered future earnings expectations. While U.S. growth could remain near expansion averages, GDP estimates in China, Europe and elsewhere have been revised down, damaging prospects for multinational U.S. firms.
While each of these factors alone may not drive equity performance in Q2, taken together they paint a picture of a likely continuation of volatility. A strong U.S. consumer and a more accommodative Fed are certainly positives in the near term; however, more structural late-cycle headwinds could quickly re-emerge.
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