Equity Market Overview

Good News

Many interim-quarter updates we send are typically in response to an unexpected market decline, so instead, we thought we would take the opportunity to provide commentary after what has been a more positive experience.

Equity markets have rebounded strongly from the panic decline of December, which pushed the U.S. equity market into a 20% bear market in the fourth quarter. From the December 24th lows through the Wednesday, February 13 close, stocks have now recouped more than half of the decline.

We certainly welcome the impressive bounce from the extreme short-term oversold condition. That said, as markets have become more comfortable with issues around Fed policy and prospective trade deal with China, we think some measure of caution remains appropriate.

While there is always a lack of visibility about market activity over the short-term, it seems particularly so to us right now. Our macro analysis has not given any signals that a recession is imminent, but we do take notice that economic growth and company fundamentals are trending negatively and cyclical risk indicators (yield curves, high yield spreads, and margin debt) are rising.

Given that we are going into the 10th year of an economic upswing, the probability of an economic downturn in the foreseeable future is rising. By itself, this will limit the upside opportunity for stocks, even if we muddle through another couple years of a slow growth, low interest rate environment.

More importantly, what we saw in December serves as a good reminder of the capricious nature of the markets. In the recent case, the underlying economic fundamentals held up reasonably well throughout. Should we see further signs of late-cycle deterioration, we should not be surprised to see markets become highly volatile again (exacerbated by the “machine trading” structure of the current market) and vulnerable to the wide swings in investor sentiment.

BOTTOM LINE:

The strong January/February upswing obviously increases the probability of gains for the full year, and given where markets were six weeks ago, we’re certainly appreciative of this remarkable turn-around.  However, our experience combined with our macro trend analysis process suggests that reasonable caution should continue to be in place for risk assets (equities) as the markets work through the late stages of this elongated economic cycle.

As we have indicated before, we believe risk management is best handled at the level of the individual client’s asset mix policy. It is always a good time for both the client and Meritage to review the targets and ranges, and now is no exception.

If you would like to discuss your Investment Policy guidelines with us, please contact us by phone at 913-345-7000 or e-mail: welcome@meritageportfolio.com.