The 1st quarter of 2018 was notable for the return of volatility in the stock market. After an incredibly long period of tranquility, large daily gyrations were a common occurrence in February and March. The long-awaited correction finally arrived, meaning a pullback in stocks of over 10% from previous highs. Using the Standard and Poor’s 500 as our guide, stocks hit their lowest point for the quarter on February 9th, down nearly 12% off their highs. Stocks followed script as noted in my February 6th blog with a rally off their lows followed by a so far successful retest of the lows on April 2nd. I continue to believe the most likely direction from here to be sideways, which I will discuss further in a moment.
Another significant financial market news item during the quarter was President Trump’s proposal to impose tariffs on imports from China. In the midst of this we witnessed the resignation of Gary Cohn as head of the National Economic Council. Mr. Cohn was viewed as a counterbalancing voice in the White House in favor of free trade. With his departure, there are concerns that President Trump’s protectionist agenda could move forward unfettered. This led to the stock market volatility in late March and early April. From what I have read, we currently do not have a level playing field with China with respect to trade between our countries. While trade tariffs have historically had a negative effect on jobs and the global economy, it is understandable that our country would desire a more equitable trading relationship. While President Trump’s unorthodox approach is subject to strong feelings on both sides of the aisle, I am hopeful that negotiations with China are a success and that many of the proposed tariffs end up being abandoned. It is worth noting that some of the negative outcomes that can result from a trade war include supply chain disruptions, inflation, the loss of jobs and reluctance by businesses to invest.
Despite all the fireworks and gloomy headlines, the stock market performance in the 1st quarter really wasn’t bad. U.S. stocks as measured by the S&P 500 were down just .8%. Established foreign economy stocks as measured by the MSCI EAFE index were down 1.5%, while the MSCI Emerging Market index was actually positive, up 1.4%. Bonds as measured by the Bloomberg Barclays U.S. Intermediate Government/Credit index were down 1.0%, a little worse than how the S&P 500 fared. It remains to be seen whether or not bonds will provide the downside protection investors have come to expect from them. As I noted in my letter last October, bonds may now be less effective for managing risk given the low interest rate environment and possibility of rising interest rates. Managing risk within asset classes now becomes especially important. I believe this is best accomplished by focusing on more attractive segments within an asset class, and by utilizing managers who have consistently demonstrated attractive risk-adjusted returns (recognizing of course that past performance is no guarantee of future results).
At the beginning of the year my greatest concern for the financial markets was that the economy could overheat with the recently enacted tax cuts. This could prompt the Federal Reserve to get more aggressive raising interest rates. More often than not, interest rate increases by the Fed are the precursor to the next recession. Oddly enough, the concerns now about a trade war may very well slow growth and do some of the Fed’s job for them. The result of the conflicting forces of trade war fears versus a strong economy, a healthy labor market and rising corporate profits is likely to be a sideways stock market. This could easily persist through the summer. The ebb and flow of a range-bound stock market does provide investment opportunities, in particular through portfolio rebalancing when asset classes trade near the upper and lower ends of their trading ranges.
While there has been much ado about the again-flattening yield curve (the difference between short and long-term interest rates), if it isn’t flat or inverted, it is positive. A slightly sloped yield curve has historically been very positive for stock market performance. This may very well be a sign that our Goldilocks economy (not too hot, not too cold) will continue, providing the Fed is able to exercise restraint.
As always, please let me know if there is anything we can be doing to help you.
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President, GSR Capital Management
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