It was a long time in coming, but volatility made a notable comeback in the first quarter of 2018
Is the bull market finally over? For the first time in nine calendar quarters, the U.S. investment markets delivered a negative overall return. With the combination of both stock and bond returns in negative territory this past quarter, investors have been reminded that financial markets can, and do, go down from time to time.
Many have been surprised to see bonds in negative territory first quarter. Traditional bond investments lose value when interest rates rise and generally the longer the maturity of a bond the more volatility will be experienced. We have been concerned about bonds moving down in value more than the interest payments they generate in short periods of time, given the Federal Reserve has made it clear they plan to pursue a path of raising rates. The new Fed Chairman, Jerome Powell, held his first FOMC meeting in March and raised Fed Fund rates another 0.25% (we are now at 1.75%) and plans on raising rates two or three more times in 2018.
Fear of Trade War versus the Fundamentals
Investment pundits have many triggering effects to point to recently, from chaos in the White House to the possibility of a global trade war, to fears of inflation or higher interest rates, to the simple fact that U.S. stocks have been priced much higher than their historical averages. They aren’t getting much explanatory data from the economic statistics which are mostly strong; the unemployment rate is testing record lows and new jobs are being created at record levels. More importantly, annual earnings estimates for S&P 500 companies rose 7.1% during the first three months of the year-the fastest rise since FactSet began keeping track in 1996. Clearly, these estimates are factoring in fiscal stimulus that has been put into motion over the past several months.
Ironically, the downturn in stocks since January 26th, plus the jump in earnings outlook, may have forestalled a bigger corrective bear market later. The S&P 500 is now trading at 16.1 times projected earnings for the next 12 months, compared with 18.6 in late January when the markets were extraordinarily bullish. Stocks are not as overpriced as they were, and the corporate tax cut could lead to higher than anticipated earnings as this year unfolds.
It’s too early to Sound the Bell for the End of the Bull Market…
Market volatility is back. The S&P 500 saw 23 daily moves of +/- 1% in just the first quarter compared with a total number of 48 days in 2016 and only 8 days in 2017. Although the markets were unusually “calm” from a volatility perspective in 2016 and 2017, a bumpy ride in the markets should be expected looking ahead. Keep in mind volatility doesn’t necessarily mean the end to a bull market. We believe investors are currently underestimating the positive effects of recent fiscal and regulatory policies while overestimating the potentially damaging impact of a “trade war” – as the market generally dislikes uncertainty most of all. While the recent trade tensions have increased the risk to the growth outlook, at present the tangible threats of trade disruptions are far insufficient to point to a near-term recession.
As always, please call with questions.
Wilshire index data: http://www.wilshire.com/Indexes/calculator/
Russell index data: http://www.ftse.com/products/indices/russell-us
S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf-p-us-l-
Nasdaq index data:
International indices: https://www.msci.com/end-of-day-data-search
Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/