First Quarter 2018 Review

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.