My F&M

1st Quarter 2018 Market Commentary

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Stocks started the year strong until turbulence erupted late in January. The month of January itself still ended in the black for stocks, but declines in February and March brought an end to a string of 15 positive months for stock returns.

As we have previously written, that long uninterrupted run of positive months for stocks was highly unusual and some volatility seemed long overdue.  Tariffs and trade war threats appear to be significant contributors to the market’s recent concerns, but higher interest rates, turnover among high-level Administration officials, and stumbles among some of the market’s “leadership” companies each likely played a part.  After having been unusually low for an extended period, volatility rose to more normal levels as stocks briefly fell about 10% from January highs.  However, for the first quarter as a whole, stocks were down only marginally with the Blended Stock Index (70% Russell 3000 and 30% MSCI ACWI ex-US Index) down just 0.7% and the S&P 500 down 0.8%.  Bonds are often considered safe havens when stock market volatility flares, but the Barclay’s Aggregate Bond Index fared a bit worse than stocks in the quarter, down 1.5%.  Real estate investment trusts were particularly weak in the first quarter, with the REIT index down 6.7%.

One trend from last year that continued was that of growth stocks outperforming value stocks in the quarter.  But with darlings like Facebook and Tesla each down about 15% this year so far, and broad damage among many of the market’s “high flyers” in recent weeks, that trend may be turning.

After several years of stock prices rising faster than earnings, the stall in stocks in the quarter coupled with nice growth in earnings has slightly moderated that imbalance. Yields on fixed income instruments remain very low, but modestly negative bond returns also mean bond yields have slightly improved.  Additionally, while still low, yields on money market funds have now at least moved above zero.

Economic growth continues to accelerate by most measures.  However, there are potential signs of overheating in the economy with consumer borrowing reaching elevated levels.  Even though there is still scant evidence of inflation, we suspect wage pressures may be building.  So far so good for both growth and inflation, but risks to each may be growing.

Each quarter tends to bring a slightly different set of near-term worries on which markets fixate.  But the longer-term picture today remains much the same as it did last year: high valuations and low yields across all traditional asset classes leave no other outcome than diminished returns over the next ten years or so.  The specific path those returns take getting there is unknowable, but that they must be lower is inescapable.  Nearer-term, the combination of unusually high valuations, an economy operating at full employment, and the Fed steadily pushing interest rates higher suggests market risks are elevated.  Accordingly, we continue to focus on risk management in portfolios.