Quarterly Update

The first quarter (Q1) of 2018 could best be summed up as a return to volatile markets. Already this year we have experienced more volatility than in all of 2017. There were six +/-2% moves for the S&P 500 during the quarter compared with zero last year. Following a year of near historic low volatility this heightened level is likely to linger for a while.

Here's a summary of how major market indexes ended the quarter:

• S&P 500: down 0.8%
• Down Jones: down 2%
• Russell 2000 (small company stocks): about flat
• MSCI EAFE (foreign stocks): down 1.4%
• MSCI EM (emerging markets): up 1.5%
• U.S. Aggregate Bonds: down 1.5%
• Municipal Bonds: down 1.6%

Stocks powered into 2018 with a continued uptrend and the S&P 500 hitting another record high in late-January. Nearly all asset classes were up early in the new year, and the rising tide seemed to be lifting all boats. But as we have discussed previously, markets can't stay quiet forever. Volatility then came roaring back as we entered February.

While there were multiple catalysts leading to the eventual market correction, the primary culprit was an ironic one: economic growth. During much of 2017 the Federal Reserve had signaled perhaps three interest rate increases during 2018 as it planned to respond to a growing economy. The stock market cheered what it felt was moderate interest rate policy, while the bond market was pricing in, perhaps pessimistically, just two rate increases.

In February, as measures of economic growth continued to show strength the stock and bond markets suddenly began to fear the Fed would raise rates faster than anticipated. This led to an almost overnight repricing of stocks, bonds, and anything sensitive to interest rates, such as REITs, that sent shivers throughout global markets.

What followed has become typical of recent market corrections. Broad stock indexes such as the S&P 500 fell the requisite 10% or more indicating a technical correction in a short period of time, in this case about two weeks. The bond market also fell during this timeframe, but by a more subdued 2.5%. Then over the following couple of weeks, through the end of February, stocks were recovering and were positive for the year but still off the highs of late-January. Bonds had come back a bit as well.

But then the focus turned to tariffs, possible trade wars, controversy at Facebook, and the POTUS Twitter account being aimed at Amazon. These topics added together to create negative sentiment, erasing the positive surge of early March, and bringing back volatility through the end of Q1.

So, here we are facing volatile markets again. Fortunately, the economic backdrop remains mostly positive. Growth numbers, such as GDP, have been revised up and unemployment remains low. Government stimulus via the recent tax overhaul has only begun to show up in the numbers and consumers and business leaders are generally optimistic. Also, none of the major economic indicators are showing a recession starting in the immediate future.

This outlook should be positive for stocks, indicating that recent volatility is a short-term phenomenon, but still could linger. Why? A recession may not be on the immediate horizon, but it's likely just beyond and the stock and bond markets are starting to reflect this. It may be that the slowness of the recovery following the Great Recession, recent tax policy changes, and the Fed's accommodative interest rate policy over the past ten years makes for a continued long economic expansion. But an economy such as ours can only grow for so long before slowing down.

In this kind of market environment fundamentals matter. Not just economic and market fundamentals but, even more importantly, investing and saving fundamentals. Being well diversified, holding high quality investments, minding your allocation, and trying not to overspend are all critically important.

Also important is asking questions. So, please let me know when you have questions and we can schedule time to review.

Have questions? Ask me. I can help.