After a terrible fourth quarter, it looks like markets are going to have a strong first quarter. U.S. indices are up more than 10 percent, and international indices aren’t far behind. The gains have been fairly steady all quarter, although there has been some weakness in March.
This rebound came despite economic and financial uncertainty, as well as significant declines in estimates of corporate earnings (which means one thing—valuations rose). The first quarter started with forward price/earning ratios at close to the lowest levels since 2013, and it ended with them close to average levels since then. The stock market, in this sense, is saying things are back to normal—a positive sign.
Although growth was reasonably strong in the last quarter of 2018 and for the entire year, expectations are for a significant slowdown in the first quarter. Based on what we know right now, those expectations seem reasonable. Growth is expected to drop from 3 percent for 2018 as a whole and 2.2 percent for the fourth quarter to 1.5 percent for the first quarter. Of course, that drop might be concerning. But looking back, we have seen weak first quarters in several past years, only to then see growth rebound. This year, there are good reasons to believe that might be the case again, as the aftershocks of the government shutdown fade. The fact that growth continues, even at a slower rate, is therefore a positive sign for the rest of the year.
The story around corporate fundamentals is similar. While expected growth has dropped significantly, it is still positive. In a normal quarter, roughly three-quarters of companies beat expectations, so the actual numbers are very likely to be even better. With valuations normalized, rising earnings would result in higher stock prices, which again could accelerate in subsequent quarters.
Coming into the year, one of the big drags on growth was the hit to confidence that the government shutdown caused. We have seen that same effect in spending and business investment. With the shutdown over and other political risks—the Mueller report, Brexit, and even the trade war—moderating or at least becoming old news, the headwinds here should subside. This shift would also be positive.
For all the real concerns and risks, the fundamentals remain reasonably solid, and companies are on track to make more money. With a fairly valued market, based on recent data, that is a recipe for continued growth. As noted, there are reasons to believe we might end up even better than that.
That’s not to say there are not risks out there. There are, with the politics around the debt ceiling being the biggest. It is to say, however, that the message from the first quarter is overall much more positive, for both the economy and the markets, than the headlines would suggest.