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Where Are All the Mixed Signals Are Coming From?

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Written by: Mark Lacuesta, FRM, CAIA, CIPM

Markets

March market breadth was positive across multiple asset classes. U.S. Equities were positive with the S&P 500 Index returning 1.94% and the MSCI EAFE Index also positive at 0.97%. Major fixed income asset classes were also positive during the month with the Bloomberg Barclays U.S. Aggregate Bond Index positive +1.92%. The Bloomberg Barclays U.S. Treasury Bond Index performed positively from the downward shift of rates across the yield curve, posting a 1.91% return. Corporate fixed income credits were also up, with Investment Grade and High Yield indexes returning 2.50% and 0.94%, respectively (as represented by the Bloomberg Barclays indexes).

Oil prices continued to rise in March as decreases in global production have helped to prop-up prices. With the U.S. Dollar Index up 0.72% versus a basket of foreign currencies, the precious metals index was down -2.19% while the industrial metals index was up 0.70% as trade discussions and the health of global economic growth continue to be debated. Agricultural commodities underperformed as the U.S. maintained its rhetoric of southern border security potentially impacting agricultural imports from southern countries.

Four of the eight hedge fund strategies were positive in March. Equity Hedge, Market Neutral, Merger Arbitrage and Global Macro strategies were positive while Relative Value strategies were negative. Among the Event-Driven strategies, Merger Arbitrage was positive and Event-Driven and Distressed strategies were negative.

Economic Data

U.S. fourth quarter GDP was adjusted to 2.2%, down from the earlier advanced figure of 2.6%. Personal Consumption figures were also down, 2.5% from 2.8%.

From a labor standpoint, payroll figures surprised on the downside when the change in non-farm payrolls was reported at 20,000, down from the prior 304,000 and far-off the survey estimate of 180,000. Unit Labor Costs rose by over a per-cent to 2.0% from 0.9%. While the Labor Force Participation Rate stayed firm at 63.2%, the underemployment rate dropped to 7.3% from 8.1% and the unemployment rate dropped to 3.8% from 4.0%.

While often cited as a measure of inflation, CPI is up 1.5% year-over-year while Core CPI (ex-Food & Energy) is up 2.1%. The Fed’s preferred measure of inflation, the PCE, showed a similar result with PCE up 1.4% and Core PCE up 1.8%.

The Conference Board Consumer Confidence IndexTM is 124.1, down from 131.4 from the prior report.

These figures may indicate some of the results of the late-cycle fiscal stimulus beginning to wear off. While labor seems to be tightening, inflation seems to be more muted with the PCE indicators below the Fed’s target level.

Central Bank

The Fed meeting for March 20 concluded with no increase in rates, which was in-line with their most recent dovish pivot. Rate hike expectations for 2019 has dropped to 0 from two. Further, the balance sheet reduction has been replaced with a tapering and then a stabilization of the $3.5T balance. In effect, the maintenance of rates and the balance sheet keeps the level of the monetary liquidity in place considering the softening economic conditions.

Mixed-Signals

While equity markets have been performing positively year-to-date, the mixed signals coming from reported economic data, the Federal Reserve, and the election rhetoric that usually accompanies primary-election politics may generate uncertain risks in the near term.

By the close of March, the yield curve inverted with the 10-year yield falling just below the 6M, meaning the yield on a 6-month treasury bill was higher than a 10-year note. While it’s often cited that yield-curve inversions have preceded recessions, it doesn’t necessarily follow that yield-curve inversions cause recessions.

While the recent inversion has been attributed to the signs of a slowing economy and the recent reversal of the Fed’s stance on rate increases, U.S. employment levels remains robust and the U.S. economy is still relatively strong globally. Due to this, there is still some reason to believe overall consumption will help push GDP growth.

As the Fed has also signaled a slowing of rate hike increases, corporate credit markets have responded positively as overall credit risk from corporate leverage is reduced.

With various signals to weigh, investors should consider any pent-up volatility to inform their portfolio positioning.

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