Market Review First Quarter 2018
Both equity and bond markets showed negative performance for
the quarter. The bond market continued to show response to the Federal Reserve policy
of raising interest rates. Equities showed the impact of both higher interest
rates and uncertainty over future economic/political policies.
Equity markets:
Stock markets showed extreme volatility as market participants displayed
uncertainty towards future fundamentals. But just as important was the
consequence of the large concentration of the market increases in the past year
of a handful of stocks particularly those referred to as FAAMG (Facebook,
Apple, Amazon, Microsoft and Google.
The concentration of this movement means that the S+P 500
has an extremely large weighting in these stocks. Furthermore, stocks in the
technology sector have also increased in weighting over the past years. The
large holdings in these stocks also come from holders of sector ETFs and
actively managed funds chasing performance. The consequence is that when there
is a selloff in these stocks there is a cascade of selling followed in turn by
momentum traders.
Among these stocks Facebook and Amazon (and perhaps Google)
may face regulatory challenges that may justify some revaluation of their stock
value. Otherwise the overall earnings prospects for the technology sector
remains in place.
The fundamentals of the US economy also remain in place. But the potential challenges
from poorly thought out trade policies hang over the market.
In sum, greater volatility can be expected and further
declines in the market not unexpected particularly given the tendency of the
market to develop a momentum of its own.
Among “smart beta” factors momentum continued to show
outperformance despite the selloff in technology in March. Value and Quality
showed strong relative performance in March.
Major US Market Indices
Symbol
|
Category
|
1Q 2018
|
1 year
|
3 year
|
SPY
|
SP 500
|
-1.0%
|
13.8%
|
34.3%
|
Mtum
|
Momentum
|
3.0%
|
29.6%
|
54.5%
|
Prf
|
US Large Value
|
-2.7%
|
9.8%
|
27.4%
|
QUAL
|
US Quality
|
0.2%
|
15.7%
|
36.3%
|
USMV
|
US Minimum Volatility
|
-1.2%
|
10.8%
|
32.9%
|
VBR
|
US Small Value
|
-2.1%
|
8.3%
|
25.5%
|
International Stocks
Influenced less by changes in US bond markets Asian markets
continued their trend of outperformance vs.US stocks. Emerging markets and
particularly Asia based on current market conditions are attractively valued vs
the rest of the world…. but of course, the future of US Asian trade policy
makes forecasts difficult at best.
The overall European Union stocks continued recent
outperformance vs the US. Changes in trade policy, albeit to a lesser extent
impact outlooks here as well. The European Central Bank has not moved to a
tightening mode which is a positive. Germany underperformed the overall
European Union likely due to domestic political developments. European stocks
have continued to perform the index of all deloped markets. Emerging Asia has
continued to outperform the rest of emerging markets.
Major International Indices
Symbol
|
Category
|
1Q 2018
|
1 year
|
3 years
|
VWO
|
Total Emerging Markets
|
0.9%
|
21.6%
|
24.5%
|
EFA
|
Total Developed Markets
|
-0.2%
|
14.9%
|
18.0%
|
GMF
|
Emerging Asia
|
2.0%
|
25.2%
|
30.6%
|
EZU
|
European Union
|
-0.1%
|
17.4%
|
18.8%
|
EWG
|
Germany
|
-3.0%
|
13.8%
|
12.4%
|
Bond Market
The Federal Reserve raised interest rates for the fourth
time this year on March 21, the first time umder the new Fed Chairman Powell.
While it seems near certain further hikes will occur this year the pace is
uncertain much dependent on future data on inflation and the overall economy.
The yield on the ten-year Treasury bond hit 2.95% at the end of February the
high for 2018. It ended 2017 at 2.45%. At the end of the quarter it fell a bit
to 2.74%. Shorter term rates have risen as well in what is called a “flattening/flat
yield curve (narrowing of the differential between 2 years and 10-year interest
rates) the two-year treasury reached a high 0f 2.30% on March 19, up from 1.88%
at the end of 2017 and ended the quarter at 2.25%
Even with this development in the yield curve the bond
allocation in portfolios benefitted from the strategy of keeping
maturities/duration short. Short term high yield continued to perform strongly
reflecting positive prospects for the economy.
Major Bond Market Indices
Symbol
|
Category
|
1Q 2018
|
1 year
|
3 years
|
AGG
|
Aggregate US Bond Index
|
-1.5%
|
1.1%
|
3.6%
|
BSV
|
Aggregate Short-Term Bonds
|
-0.5%
|
0.1%
|
2.1%
|
VCSH
|
Short Term Corporate Bonds
|
-0.7%
|
0.7%
|
4.4%
|
vgsh
|
Short Term Government Bonds
|
-0.2%
|
-0.1%
|
1.0%
|
SJNK
|
Short Term High Yield Bonds
|
0.2%
|
3.7%
|
10.8%
|
Looking Forward
As JP Morgan was famously said to have replied when asked
for his market forecast his response was “they will fluctuate”.
It seems highly likely that those fluctuations will continue
to be above historical levels going forward. The concentration of holdings in a
few stocks and in the technology, sector will have an outside impact on
returns. The growth of momentum traders both institutional and individual (many
using ETFs) will be a short-term factor. More fundamental factors such as the
uncertainties over trade policy and future interest rate changes will affect
markets as well. A year of low single digits or negative returns should not
surprise investors given the outsize gains of recent years.
Of course, the fundamental advice to investors is, as always
to be comfortable to the level of risk in their portfolio and to stay the
course. Given that short term fluctuations are best ignored.