First Quarter 2018 Market Review

The first quarter of 2018 saw the return of volatility, of which we have not seen in over a year as equity markets have largely marched upward without interruption.

While we entered January with overwhelming optimism in the market, volatility returned at the beginning of February. Fluctuations have begun to rattle some investors, with the culprit changing on any given day. One week, the concerns may be around a handful of large tech companies, the next it is tough rhetoric about tariffs and global trade. On top of this, we have a Federal Reserve that is gradually returning us to a more normalized monetary policy after years of unprecedented low interest rates. Military conflict concerns have also risen adding to investor fears.

Panic Is Not an Investment Strategy

This is a lot for investors to digest and as emotions kick in, the media knows this and uses it to keep you watching. There is always a story that seizes the topic of the day and describes a crisis in the making. As always, it is important to take a step back and put everything into context. There will always be issues and challenges that face our economy and country. Short-term fluctuations in the market are often attributed to highly selective and simplified emotional news of the day rather than the longer-term fundamentals that are key to investing. You’ve likely heard the phrase, “Panic is not an investment strategy.” The markets are more complex than the news may lead us to believe and serves as a reminder that the focus should be on good planning. Markets do not move in only one direction and corrections are an important part of long-term investment success.

Market Indicators, Corporate Earnings and Inflation

Aside from the headlines, we need to pay attention to certain market news and indicators. The bull market is over nine years old and we are perhaps in the later stages of the business cycle. There have been some signs of weakening in the economy, but these may be more related to a 20-year track record of weaker first-quarter economic results and not necessarily a trend related to today’s economy. Both the manufacturing and non-manufacturing Supply Management (ISM) indices slipped last month which are important indicators to watch, but they both remain well over 50 which is a measure of expansion and not contraction in the economy.

Manufacturing is reporting a large backlog of orders which is a good sign. Business confidence also remains elevated. Corporate earnings are now coming in and look relatively good with some exceptions particularly in the technology space. In general; earnings growth remains strong.

The Federal Reserve (Fed) seems to be stepping up the pace of monetary tightening to reduce the risk of inflation, which is a market risk that investors often overlook. The new Fed chair has indicated a desire to raise rates further and reduce the balance sheet. If inflation does heat up, the Federal Reserve may become more aggressive on interest rate hikes and in turn put downward pressure on the market. Thus far, it appears that the current interest rate environment is more of a normalization of Federal Reserve Policy than a sign of a looming recession. Monetary policy remains an important consideration in evaluating asset prices.

Then there are trade wars and actual military wars to worry about. Thus far, the trade wars have been more about rhetoric than actual action and there are many signs that proposals are well underway to get better trade agreements in place. It also does not appear that the situation in Syria will become a major market mover other than in the short-term as the objective was more about the use of chemical weapons than to start a major military objective.

Focus on Diversified Portfolios

While a recession does not appear imminent it is worth noting that we are in the later stages of the economic cycle and portfolios should take of advantage of new opportunities that may arise. Treasuries now offer better yields than in many years and offer diversification benefits for otherwise risky portfolios. Credit risks typically widen before stocks peak. While this has not yet happened, investors should consider moving fixed income to higher credits and shorter maturities.

In summary, there is a lot of news that has brought volatility back to the markets and monetary conditions are tightening, but the economy is still pushing ahead in ways that are still supportive of stocks. Volatility will likely continue to dominate the markets in the near future; investors should be prepared for this with the understanding that long-term investors have no reason to panic. Portfolios should be well diversified with liquidity and flexibility to adjust to new opportunities as they become available.

We will continue to have discussions with our clients, evaluating portfolio asset allocations to ensure that they are appropriate for stated goals and objectives. Your questions and concerns are extremely important to us, so please continue to reach out with anything you may need.

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