1Q 2018 Economic / Market Recap
The stock market giveth, and the stock market taketh away. January was marked by an “irrational exuberance” style stock market rally. February and March erased all the gains and then some. In short, volatility, absent in 2017, returned with a vengeance.
For the first quarter of 2018, according to Morningstar, the following indexes posted unimpressive returns:
S&P 500 Index: -1.17%
DOW Jones Industrial Average: -2.26%
Morningstar Europe: -2.09%
Morningstar Asia: .20%
Barclay’s U.S. Bond Aggregate: -1.80%
The first quarter reminds us of the old song “Nowhere to Run” by Martha & The Vandellas—“got nowhere to run to, baby, nowhere to hide…”
With nowhere to hide in the first quarter, it’s important for investors to look at the second quarter and beyond.
Our contention is that global economic fundamentals are strong and improving.
In the U.S., the 4th quarter gross domestic product (GDP) numbers were raised from an initial estimate of 2.5% to an actual rate of growth of 2.9% These numbers reflected a big increase in consumer spending and higher investment in business inventories. This, coupled with the tax cuts signed into law by President Trump in 2017, is good momentum for a strong U.S. economy to get stronger as the year progresses.
Synchronized global economic growth for 2018 looks strong. The International Monetary Fund expects global GDP to increase by 3.7% for the year. The U.S. is projected to grow 2.7% with Europe at 4% and Asia at 6.5%.
The Federal Reserve, under new leadership with Jerome Powell replacing Janet Yellen as chairperson, has been very clear about their intentions to raise rates three times this year. This plan has been well announced and is of no surprise to the financial markets. The Fed believes the economy is strong enough to withstand these increases in short term rates—we tend to agree. Even still, we regard current monetary policy to be largely accommodative as rates still have a long way to go before they are historically “normal.”
With discussion and concern about future inflation, the current rate of inflation in the U.S. remains in check. Over the past six months, the core index of the CPI has risen at an annualized rate of 2.2%. This rate has ticked up slightly over the last year, so this is something to watch.
The so called “trade war” could produce some short term economic disruption. We tend to think these trade issues are more rhetoric than reality, at least for now. Trumps’ steel and aluminum tariffs went into effect last week, but key trading regions were granted waivers including Mexico, Canada, Argentina, Brazil, Australia, South Korea, and the entire Eurozone . In taking a step back, it seems that most of the trade discussion is about political posturing rather than economic reality. If an all-out trade war does ensue, China has much more to lose than the U.S. In 2016, 23% of China’s exports went to the U.S. while only 8% of U.S. exports went to China . This is worth watching and may cause some short-term volatility, but our judgement is it will play out without calamity.
Stocks have been wallowing in their first correction (defined as a short-term decline of 10% or more) in more than two years. This particular one was interesting in that it produced the shortest correction in decades with U.S. stocks hitting their all-time high in January only to lose 10% in a matter of 9 trading days in February. The market has also been prone to a few daily white-knuckle swings. On April 4, the DOW at one point was down for the day by 510 points, only to finish the day up by 240 points—a 750-point swing in one day!
The key question is what is going on and is this normal or not?
First of all, as we have said before, last year was marked by record low volatility. Things have a way of reverting to the mean. We think to some degree lasts years low volatility will be counterbalanced by this year’s high volatility.
Secondly, stock market volatility is historically common. The market, on average, regularly has several pull backs a year in the 5% to 10% range. It never seems normal and there is always good reasoning about the retreat in the moment.
The current fears of the moment are a trade war, overly aggressive Fed action, and weak corporate earnings growth. As we have outlined above, we feel pretty solid about all those things.
We are viewing these pullbacks as an opportunity to invest cash that has been sitting on the sidelines. With fundamentals strong, the effect of the list of potentially recession inducing factors is likely exaggerated.
What To Do Now
We think the smart thing to do now is for investors to revisit the fundamentals.
We are mostly fair-weather basketball fans meaning we watch a little basketball in the early and mid-part of the season and a lot of basketball in March. At least the first half of the Villanova, Michigan game was a good one. What do you think the Michigan coach will focus on in the first practice next season? Our guess is the fundamentals—passing, free throw shooting, and teamwork.
What are the fundamentals for investors?
1. Remain committed to a sensible long-term investment strategy that meet your individual goals, time horizon, and risk tolerance.
2. Don’t put all your eggs in one basket—diversify. A mix of stocks, bonds, alternatives, and cash is good for almost all investors.
3. If you are still saving and investing, try to increase the amount you put away on a consistent basis. You can’t control market events and the economy, but you do control your rate of savings.
4. Control your spending and live within your means. Again, this is within your control.
5. Be informed, but don’t overreact to daily news. There is more information available to investors today than ever before in history. We would argue, however, there is a shortage of wisdom to apply that information. Don’t be information rich and wisdom poor!
We hope all of you had a terrific Easter weekend and are enjoying a great spring! Thanks for giving us the opportunity to serve you and your family.
American Funds Outlook 2018.
Nuveen weekly commentary 26 March, 2018.
Nuveen weekly commentary 26 March, 2018.