| April 01, 2018

Long-absent volatility returned to the markets in the beginning of this year. Multiple macroeconomic surprises erased January’s strong gains in US stocks and caused the S&P 500 to finish the quarter with a small loss. If there’s a single reason for the market’s slump in 2018, it is the uptick in “uncertainty” during the 1st quarter. (Volatility remains elevated in early April.)

Uncertainty has cropped up in several places for investors…

First, there is Federal Reserve uncertainty. The Fed hiked rates in late March and made waves with a more aggressive plan for 2019 than was predicted earlier. If inflation picks up, that has historically resulted in the Fed hiking rates more quickly. Fed-watchers fear new Fed chair Jerome Powell is more focused on normalizing short-term rates – and the potential for “too much, too soon” rate hikes – than supporting the economy.

Second, there is trade war uncertainty – specifically, the Trump administration announced proposed tariffs on steel and aluminum imports. Followed by the administration tacking on up to $60 billion on Chinese imports. China countered. Their proposed tariffs on US goods totaled $50 billion. A tit-for-tat trade fight is still unraveling.

And third, there is technology uncertainty for a change. America’s favorite five growth stocks (“FAANG” – Facebook, Apple, Amazon, Netflix, and Google’s Alphabet) account for over an 11% weighting in the S&P 500. While this group has provided long-term market leadership, including a stellar start to the year (up an average of 13.23%), they were subjected to uncharacteristic stress tests by quarter end. A few bad business practice allegations (i.e., Amazon and Facebook) sparked uneasiness for technology’s sweethearts by quarter end.

Even though market volatility spiked during the quarter, in part due to these uncertainties, the fundamental foundation behind this multi-year market rally remains steadfast. Strong economic data reports and growing corporate earnings that helped propel stocks higher in 2017 were still in place in the 1st quarter – namely, the Atlanta Fed’s recent estimates of Q1 GDP were between 2%-3% and earnings expectations are higher for both this year and next.

In sum, while an increase in macro-economic uncertainty did cause an uptick in market volatility, the longer-term, fundamental drivers of stock performance persist. That context is important to keep in mind as we enter a new quarter.

1st Quarter Performance Review – A Rare Down Quarter for Most Asset

The 1st quarter of 2018 reminded us that markets can – and will – go down. While there were outliers, many asset classes, indices, and categories declined in terms of total return.

In the US, most broader equity indices declined modestly. Coming off nine consecutive quarters of positive returns, the S&P 500 finished in negative territory this past quarter. After a booming January (up 5.73%), the widely-followed benchmark fell in both February and March. For the quarter, the S&P 500 lost 0.76%. The index has had only one other down quarter in the last five years.

By market capitalization, small-cap stocks outperformed large-cap stocks. From a style perspective, growth stocks beat value stocks. In terms of sector performance, only two sectors (consumer discretionary and technology) finished the quarter in the black. Among the nine sectors in the red, telecom, consumer staples, energy, materials, and real estate all dropped more than 5%.

Source: Morningstar

Outside the US, foreign-developed equity markets dropped 1.53%, but emerging market equities bucked the trend with a gain of 1.42%. Emerging markets have both momentum, growth, and valuation on their side. Additionally, they are still outperforming – and cheaper than – developed markets (including, the US).

Source: Morningstar

Turning to commodities, they rose in aggregate during the first quarter, driven by gains in gold and oil. Gold rallied on a combination of rising inflation and growing macro-economic uncertainty. It maintained its “safe-haven” designation during volatile markets. Oil, meanwhile, also rose, thanks to continued global production outages and geo-political tensions in the Middle East. In general, a basket of broad-based commodities had a decent quarter on a relative basis.

Source: Morningstar

Switching to fixed income, the leading benchmark for bonds (Bloomberg Barclays US Aggregate Bond Index) lost 1.46% for the quarter. Nearly all other major US bond categories posted negative returns, as well. The exception was T-bills. Bloomberg reports that the iShares Short Treasury Bond ETF (SHV), an $11.7 billion fund focusing on treasury bonds with remaining maturities between one month and one year, received approximately $1.4 billion of inflows the last week of March. Rising interest rates, a flattening yield curve, and inflation concerns sent a good chunk of fund flows on a flight to safety (short-duration funds).

Source: Morningstar

2nd Quarter – and Rest of the Year – Market Outlook

Looking forward, we expect heightened volatility to persist in the 2nd quarter and possibly for all of 2018. As mentioned, uncertainties such as Fed policy, trade war worries, and technology company crackdowns remain. In addition, other forces – both potentially positive and negative – are at work. Those include: the impact of Washington, D.C. decisions (tax cuts, personnel shakeups, and impromptu White House tweets), data breaches, and whether companies can meet or exceed rising corporate earnings expectations.

Unfortunately, except for earnings, there is no clear timetable for when these uncertainties get resolved. That means it will be an ongoing process throughout this quarter – and beyond – that heeds keeping a watchful eye on financial markets, economic news, and political moves.

As a long-term investor, it’s worth reviewing the last several years of returns for the broader stock market. Since the bottom on 3/9/09, the S&P 500 has risen over 370% (total return). During those nine years, the index underwent five separate corrections of at least 10%, but less than 20%. The end dates of those five corrections were 7/2/10, 10/3/11, 8/25/15, 2/11/16, and 2/8/18. And although we experienced our first correction in some time, the S&P 500’s fractional decline in the 1st quarter was really just a blip on the radar. Patient, long-term investors have been rewarded through this ongoing bull market.

To that point, while increased market volatility in the first quarter came as a surprise, the markets have just returned to more historical levels of volatility.

At CPK Wealth Management, we understand the risks facing this market and are committed to helping you navigate this shifting environment. However, we also recognize successful investing is a marathon, not a sprint. Corrections, volatility, and short-term events are unlikely to alter a diversified approach set up to meet your long-term investment goals. Therefore, it’s critical for investors to stay invested, remain patient, and stick to a plan. That’s why we’ve worked diligently with you to establish a personal allocation target based on your financial position, risk tolerance, and investment time horizon.

Thank you for your ongoing confidence and trust. Please feel free to contact us with any questions, comments, or to schedule a portfolio review.

Chad Kunc, AAMS®
CPK Wealth Management
12381 South Cleveland Avenue
Suite 102
Fort Myers, Florida 33907
Office: 239-230-2177
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Email: [email protected]