Quarterly Market Commentary Q1 2018

Markets in Review

Markets were moody during the first quarter of 2018 – sizzling to record levels in January, correcting in February and then continuing to decline in March. The first quarter saw a lot of activity, including the return of volatility, the signing of the Tax Cuts and Jobs Act, fears of inflation rising unabated and more rate hikes from the Fed, a potential trade war between the U.S. and China and an about-face from tech stocks.

  • The Dow Jones Industrial Average fared the worst of the major U.S. market indices, losing 2.5% over the quarter and ending its streak of nine quarterly gains, which happens to be the longest streak since the 11-quarter rally that ended in the third quarter of 1997.
  • The S&P 500 lost 1.2% for the first quarter and it too ended its nine-quarter streak. And this was the first quarterly loss for the S&P 500 since 2015.
  • NASDAQ, on the other hand, was up 2.3% for the quarter, which is its seventh straight quarterly gain.

Sizzling January, Correction in February and Losses in March

January got off to a sizzling start, with the DJIA, S&P 500 and NASDAQ leaping by 5.8%, 5.6% and 7.4%, respectively. And many market experts attribute the sizzle to a fantastic fourth-quarter earnings season and the passing of the Tax Cuts and Jobs Act of 2017. For backdrop, consider this from research firm FactSet:

  • 77% of S&P 500 companies exceeded sales estimates
  • The S&P 500 reported revenue growth of 8.2% for the fourth quarter – the highest growth since the fourth quarter of 2011

Then February ushered in unanticipated corrections (meaning declines of more than 10%) of the key indexes from their all-time highs achieved on January 26th. An end of month rally improved the numbers somewhat, but February ended with the DJIA, the S&P 500 and NASDAQ declining 4.3%, 3.9% and 1.9%, respectively.

Let’s look at how the markets performed in March and to end the first quarter of 2018:

Index Returns 1 Month 1Q2018 1 Year 3 Year
S&P 500 -2.69% -1.22% 11.77% 27.71%
DJIA -3.70% -2.49% 16.65% 35.59%
S&P MidCap 400 0.76% -1.15% 9.25% 23.28%
S&P Small Cap 600 1.86% 0.23% 11.17% 30.31%

Source: S&P Dow Jones Indices LLC. Data as of March 29, 2018. Past performance is no guarantee of future results. Returns shown are price returns

The Return of Volatility

We went into the beginning of 2018 knowing that the previous year brought us the lowest levels of volatility in decades – in fact, the market’s so called fear index, the VIX, hit an all-time low in November of 2017. But by the time we reached the end of the first quarter in 2018, the VIX had increased a whopping 81%, its highest advance since the third quarter of 2011.

Let’s look at volatility another way: in the first quarter, the S&P 500 had 12 days where it was up over 1% and 11 days where it was down at least 1%. And there were only 4 such days for all of 2017.

Looking at days where the market moved 2%, we see that there was only 1 day where the market moved more than 2% and 5 days where the market moved down more than 2% in the first quarter. In 2017, there were no 2% moves. That’s volatility.

The End of the Nine-Year-Old Bull Market?

Market experts found themselves debating whether or not the first quarter of 2018 marked the beginning of the end of the 9-year old bull market, which started on March 9, 2009 and is now up almost 300% for an annualized gain of 16.2%.

The high came on January 26, 2018 and over the past 9-years the market reached 202 new closing highs, with 84 of them coming since Trump was elected President and 14 of them this past January. But the S&P 500 officially hit correction territory on February 8th as it had declined 10.16% since its high.

Sector Rotations?

For the first quarter, of the 11 S&P 500 sectors, 9 were down. The Telecommunication Services sector did the worst, dropping 8.68% whereas the Information Technology sector did the best, posting a gain of 3.20% for the quarter.

Further, of the 500 companies in the S&P 500, we saw 296 of them lose value and 208 of them gain (there are actually 504 companies in the S&P 500, but S&P 504 doesn’t sound as clean). And the average S&P 500 company lost 1.16% for the quarter.

Sectors 1 Month 1Q2018 1 Year 3 Year 5 Year
Energy 1.55% -6.58% -3.06% -11.92% -14.67%
Materials -4.45% -5.96% 8.40% 16.26% 43.96%
Industrials -2.77% -2.02% 11.67% 30.29% 72.69%
Consumer Discretionary -2.46% 2.76% 15.24% 34.98% 92.01%
Consumer Staples -1.32% -7.77% -3.57% 8.06% 31.98%
Healthcare -3.21% -1.63% 9.42% 11.89% 76.36%
Financials -4.46% -1.38% 15.95% 40.80% 86.43%
Information Technology -3.95% 3.20% 25.98% 64.71% 136.19%
Telecommunication -1.12% -8.68% -9.56% -0.84% -4.03%
Utilities 3.41% -4.20% -1.58% 13.50% 28.91%
Real Estate 3.26% -5.79 -1.72% -0.62% 20.56%
S&P 500 -2.69% -1.22% 11.77% 27.71% 68.30%

Source: S&P Dow Jones Indices LLC. Data as of March 29, 2018. Past performance is no guarantee of future results. Returns shown are price returns

Fixed Income

For most of the first quarter, the yield on the 10-year U.S. Treasury ticked upward from the low from July 2016. By the end of March, the 10-year Treasury yield was around 2.74%, but news that the Fed might target more rate hikes in 2018 could keep yields more in check throughout the year

Markets Around the World

For the most part, markets around the world moved closely together, but there were for sure some differences:

Sectors 1 Month 1Q2018 1 Year 2 Year 3 Year
Global Markets -2.16% -1.36% 13.01% 27.81% 19.90%
Global Markets Ex-U.S. -2.18% -1.69% 14.36% 26.21% 13.66%
International Developed Markets -2.08% 1.64% 12.18% 26.61% 19.77%
International Developed Markets Ex-U.S. -2.00% -2.42% 12.75% 23.12% 11.93%
Emerging Markets -2.83% 1.02% 20.59% 38.96% 20.15%

Source: S&P Dow Jones Indices LLC. Data as of March 29, 2018. Past performance is no guarantee of future results. Returns shown are price returns

Tax Reform

On December 22nd, President Trump signed into law the Tax Cuts and Jobs Act, a measure that has been characterized as the first major reform of the Internal Revenue Code in 31 years. In a nutshell, the legislation slashes the top corporate tax rate to 21%, lowers the top marginal rate for individual taxpayers to 37%, eliminates or scales back several popular deductions, reduces taxes on business income earned by pass-through businesses, doubles the estate tax exemption, and substantially enhances immediate expensing of capital investments.

If you think that the Tax Cuts and Jobs Act is not a big deal, consider this: FactSet reported that the term “tax reform” was mentioned at least once during the earnings calls of 383 S&P 500 companies.

Trade Wars or Negotiation Tactics?

Trade war rhetoric continued to dominate news from Washington, with President Trump announcing tariffs on steel and aluminum. But within a pretty short time of being announced, almost every major exporter of steel into the U.S. has received a temporary exemption from the policy.

Shortly after the steel and aluminum announcement,

Trump proposed a plan to impose a 25% tariff on about $60 billion worth of U.S. imports from China. In response, Chinese officials proposed tariffs on about $3 billion of imports from the U.S. – with additional threats for more. So, investors and economists are trying to determine what it all means and, more importantly, the impact on the U.S. and global markets.

any economists suggest that the new tariffs from both sides are the beginnings of negotiations and that the prospects for a real trade war are not very high. And for perspective, it’s important to know that the $60 billion in U.S. imports represents half of 1% of all global trade. Further, while $60 billion is a very large number, it is only a very small piece of the $11 trillion Chinese economy.

The Federal Reserve

The Federal Open Market Committee met in March and it was the first one run by new Fed Chairman Jerome Powell. As everyone expected, the meeting brought a 25-basis-point increase in the federal funds rate. For those counting, this latest hike is the sixth Fed hike of the current cycle and the first one in 2018.

Since it was Powell’s first meeting, his comments were over-analyzed as experts tried to decipher and then determine whether the Fed will raise rates three more times or twice. One quote from Powell that continues to be talked about until the next Fed meeting was this: “We’re trying to take that middle ground.”

While Powell’s comments are sure to be talked about for a long time, most would concede that Powell was talking about a neutral fed funds rate – meaning one that neither stimulates or restrains economic growth.

Solid Economic Data

The Bureau of Labor Statistics reported that the economy continues to add jobs and the unemployment rate has remained virtually unchanged at 4.1%, its lowest level in 18 years.

Further, the participation rate (the labor force as a % of the U.S. population) increased to 63.0% from 62.7% as the labor force grew the most since June 1983.

The figure that most Fed-watchers kept an eye on, however, was wage growth – and the Bureau of Labor Statistics reported that wages grew 2.6% over the past year, which is down from the 2.9% wage growth reported in January.

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