Quarterly Newsletter for the 1st Quarter 2018
The equity markets, in general, are off to a less than impressive start in the first quarter of 2018. On a “price return” basis, the Dow Jones Industrial Average (DJIA), returned a negative 2.49%. The Standard & Poor’s Index (S&P 500) also dropped 1.17%. One of the few indexes showing a positive return was the tech heavy NASDAQ. It was up 2.33%. Overseas, the MSCI all country ex-US Index was down 1.76%, while the MSCI Emerging Market Index gained 1.42%. In the fixed income environment, 3-month Treasuries increased their returns slightly- yielding 0.35% for the first quarter.
Fixed Income Market: As you may recall, the Federal Reserve raised rates 0.25% in December and again in March. Additionally, the Fed has predicted two (2) or three (3) more rate increases in 2018. They continue to focus on inflation and CPI (Consumer Price Index) numbers as their guide to future rate increases. Over the past several months, we have seen a “flattening” of interest rates. This occurs when short term rates and long-term rates are almost identical. We have stated, on several occasions, that when interest rates rise, the underlying value of a bond drops. We are seeing this happen now. As an example, the Vanguard Short-Term Bond Fund had a total return of negative 0.51% in the first quarter. Despite the fact that the fund generates interest income, the increase in interest rates lead to the underlying value of the fund going down and an overall or total return that was negative. We believe that this scenario will continue for a while- until interest rates stabilize; thus, we favor the stability of and the approximate 1% return of the money market over most other fixed income investments.
US Stock Equities: The first quarter of 2018 was unlike anything that we experienced in 2017. The market surged out the gates as the S&P was up approximately 8% through January 26th. This was one of the best Januarys in over twenty years. Suddenly, however, we incurred a short, but sharp, 10% correction. This was the first 10% correction that we experienced since early 2016. Easing monitory policies and the threat of rising inflation concerned investors and paved the way for market volatility. As described above, this volatility, in turn, led to negative returns for both the S&P and the DJIA. Despite the results of the first quarter, the U.S. economy continues to grow, unemployment is at a historic low, consumer confidence remains high and corporations are profitable. In addition, the effects of the new income tax laws are starting to be realized by both individuals and businesses. Individuals are beginning to spend or invest more- both are good for the stock market. Corporations are beginning to show higher profits- this is good for their PE (price/earnings) ratios and should lead to increased valuations. The US economy may be entering its later stages of expansion and this could continue to add upward pressure on inflation; but, we continue to believe that the long-term outlook for stocks, be they a bit less than historical averages, is still positive.
Overseas Markets: The overseas markets mirrored the US market to the extent that they were up significantly in January, then experienced a short and sudden correction. One detriment to overseas stock prices was the US market correction. This, combined with the threat of tariffs and global trade wars, resulted in volatility and negative returns (except in the emerging markets) for the first quarter. The outlook for both developed and emerging markets, however, continues to be positive. As stated in our previous newsletter, valuations of overseas companies in developed countries remain modest, while the valuations of companies in emerging market countries appear to be comparatively cheap. Thus, we expect the overseas market to be positive in 2018.
Conclusion: The equity (stock) markets, both US and overseas, will probably be more volatile than we have witnessed recently; however, we believe they will both finish the year with positive results. The fixed income (bond) environment is feeling the effects of rising interest rates; thus, we are now negative on these investments and favor Money Markets over bonds.
Permit to us to express our sincere appreciation for the opportunity to be of service to you. As always, should you have any questions or wish to discuss the above in more detail, please do not hesitate to contact us at (717) 569-6667.