It is said ‘volatility is the price investors pay for higher returns’. We experienced remarkably tranquil markets for many months in 2017, but this year we’re also reminded ‘there is no free lunch’. The calm came to an abrupt end in the first quarter 2018 when market volatility sparked life and the S&P 500 gained or lost more than 1% on a daily basis 23 times. Markets continue to be worried about the lateness of the economic cycle, inflation, and trade war to real war concerns.
In the first quarter of 2018, the broad U.S. equity market declined 0.61% and the large-cap focused S&P 500 Index slipped 0.76%. The quarter marked the first time the indexes posted a quarterly loss since the third quarter 2015. Based on MSCI USA indexes, mid-capitalization stocks fared better than small- and large-cap stocks, and growth-oriented stocks outpaced their value-oriented brethren across the market capitalization spectrum.
Sector wise, only two of the 11 economic sectors within the S&P 500 Index posted gains in the first quarter: Information Technology and Consumer Discretionary. Conversely, the Telecommunication Services and Consumer Staples sectors posted the biggest losses.
International equity markets posted mixed results in the first quarter. International developed markets, as measured by the MSCI EAFE Index declined 1.53%. Emerging equity markets, as measured by the MSCI Emerging Markets Index fared better than developed equity markets, gaining 1.42% in the first quarter 2018.
Bond markets posted mixed results in the first quarter, with most major indexes and sectors posting losses and a few posting gains. The broad U.S. bond market, as measured by the Bloomberg Barclays U.S. Aggregate Bond Index, declined 1.5% in the first quarter. Shorter-duration maturities fared better than longer-duration maturities. The yield on the benchmark 10-year U.S. Treasury note ended the first quarter at 2.74%, up from 2.40% at the end of 2017.
During the quarter, investor optimism became tested as the Trump administration announced tariffs on steel and aluminum imports. A restrictive trade policy is stagflationary, which means it creates reductions in output and causes inflation which will not help stocks or bonds. Yet, as markets digested the prospects for trade policy and repercussions, on April 11th Chinese President Xi Jinping’s economic speech signaled significant concessions, greatly increasing the odds for future compromises in a trade deal for both sides.
Looking forward the aftereffects of new, lower corporate tax rates in the U.S. should continue to provide a tailwind to U.S. equities. Furthermore, the move to a territorial tax system (repatriation) is also likely a long-term net positive for U.S. corporations. Also, somewhat lower tax withholding rates for the majority of Americans will likely help the U.S. consumer continue to improve balance sheets.
As we enter into the rest of the year, numerous political concerns mount and geopolitical concerns pose serious challenges for asset allocators. Issues will likely arise in a sudden and unpredictable fashion. While positive steps toward negotiations over North Korea look like they might come to fruition, the geopolitical hot spot, Syria, has arisen and other regions of the globe pose the potential to disrupt markets in 2018.
On the brighter side, and most importantly, we remain in a synchronized global recovery. Shorter-term indicators of macroeconomic health (consumer and business sentiment; high frequency unemployment claims) leave very little concerns about near-term downturns in economic activity in the U.S. The market’s ability to finish the recent quarter mostly unchanged despite all of the concerns is most impressive.
As expected, 2018 has become a more sobering year than 2017. Risk factors could express themselves quickly and abruptly. We emphasize a strategic and tactical risk management investing process, maintaining plans in place for whatever the future has in store, whether market scenarios become increasingly negative or surprisingly positive. We continue to advocate focusing on the long-term, with combined attention to near term risk factors to help foster a more successful navigation of 2018.
If you have questions about your investment portfolio or your financial plan, or if you would like to discuss the challenges or opportunities the current market may present for your situation, please contact us anytime at 800-KGA-4916. As always, it is a pleasure to be working together in striving to achieve your long-term financial plans and goals.
Eric W. Kendrick, CFP