Title: Market Update – 1st Quarter 2018
Rand Baughman, CFP®
The stock market ended 2017 as its 3rd best year since the Financial Crisis of 2008. Throughout January, it appeared that the first quarter would be a happy repeat of 2017’s market. Stocks steadily moved higher, setting new records with minimal volatility. Overall investor sentiment was enthusiastic with the recent passage of corporate tax cuts, along with new tax provisions that would encourage US corporations to use repatriated foreign profits to boost merger and acquisition activity and share repurchases. Strong economic data, particularly in retail sales, further boosted investor sentiment. Fourth-quarter earnings reports came in much better than expected, with overall profits for companies in the S&P 500 increasing by 15% on a year-over-year basis. The best performance since late 2011, according to FactSet. Overall, the S&P 500 ended the month up 5.88%.
But then the calendar flipped to February, and reality set in. Stock prices fell and volatility spiked, bringing an end to an especially long and steady winning streak. This was seemingly sparked by inflation fears. On February 2, the Labor Department reported that employers had added 200,000 jobs in January, modestly above expectations. The report also noted that average hourly earnings had increased 2.9% over a year earlier, the healthiest gain since 2009. Stocks plunged as investors appeared to conclude that the tight labor market was feeding through into increased labor costs while also providing the Federal Reserve with a reason to quicken its pace of interest rate hikes. The decline continued over the next four trading days as subsequent data seemed to confirm that the economy was picking up speed and perhaps in danger of overheating. The S&P 500 reached its low point for the quarter and entered correction territory – defined as a retreat of over 10% from recent highs – on February 8, following a report showing that weekly jobless claims had fallen to their lowest level since January 1973.
The prospect of increased Treasury borrowing may have added to fears of higher bond yields and interest rates. The afternoon of February 7 saw a rapid sell-off following word that Senate leaders had reached a two-year spending deal that sharply increased both defense and other forms of discretionary spending. Long-term Treasury yields reached a peak for the quarter in mid-February, with the yield on the 10-year note reaching a four-year high. Meanwhile, the Fed continued to push up short-term interest rates, announcing another quarter-point hike in the federal funds rate on March 21. The increase was widely expected.
As the quarter wound down, fears that the economy was overheating seemed to give way to concerns that growth might be undermined by trade wars. On March 1, President Trump made the surprise announcement that the U.S. would impose tariffs on imported steel and aluminum. The tariff announcement was soon followed by the departure of two leading free trade advocates in the administration, top economic advisor Gary Cohn and Secretary of State Rex Tillerson. This coupled with reports of the growing influence of senior trade advisor Peter Navarro, a noted proponent of trade restrictions, intensified trade fears. The angst skyrocketed in late March after the administration revealed that it was planning to impose tariffs on roughly $50 billion to $60 billion worth of imports from China, as well as new restrictions on technology transfers and acquisitions of U.S. firms by Chinese competitors. The Chinese Commerce Ministry referred to the tariff plans as setting a “vile precedent,” and Chinese officials declared that they would target $3 billion in U.S. goods with import duties of their own.
The end of the quarter also brought a sharp reversal in highly valued technology shares. The first blow came on March 16, when news surfaced that a British political consulting firm had made undisclosed use of Facebook customer data. Facebook’s stock tumbled in response, soon followed by shares of Twitter, Alphabet (parent of Google), and other companies perceived to be vulnerable to accusations about the misuse of customer information. Subsequently, two fatal accidents involving self-driving cars weighed on Tesla, Nvidia, and other prominent companies involved in the technology. Finally, Amazon.com shares fell following reports that President Trump was “obsessed” with the company and fell farther when the President’s tweets led to speculation that antitrust action or other regulations might follow.
The S&P 500 posted its first quarterly loss (-0.76%) since 2015. Despite sharp declines late in the period, technology shares were the best performing sector within the S&P 500. Consumer discretionary stocks were also strong thanks to strong early performance from Internet-related media and retail stocks. Consumer staples, energy, materials, and real estate sectors were weak, and the worst performing sector was telecommunications.
The mid-cap S&P Mid Cap 400 Index ended the quarter down 0.77%, and the small-cap Russell 2000 Index ended slightly better at negative 0.08%. In the bond markets, two primary bond indexes we track – the Bloomberg Barclays US Aggregate Bond Index and the Bloomberg Barclays Municipal Index – both ended the quarter down. Posting results of negative 1.46% and negative 1.11% respectively.
Even with the recent volatility we remain optimistic about the overall economy for the rest of the year. Earnings season is in full swing, with 17% of the companies in the S&P 500 having reported quarterly results through last Friday, and most of the firms in the index will report over the next two weeks.
In general, companies are expected to report an 18% jump in earnings for the quarter, according to FactSet, which would mark the highest growth rate since the first quarter of 2011. Analysts have been steadily raising their estimates as companies have touted the benefits of a lower tax rate, a healthy consumer, higher oil prices, increasing manufacturing activity and rising levels of investor confidence.
Although S&P 500 earnings are expected to rise, one question mark is can companies sustain this growth moving forward as the Federal Reserve raises rates and pushes up bond yields? In the past the Federal Reserve did a great job of communicating their intentions to raise interest rates. Will the new chairman, Jerome Powell, continue to raise interest rates in a way that is gradual? Will he have the same open communication policy Janet Yellen did? So far, everything we see points to a “Yes” for these questions, but they are something to keep an eye on. Typically, higher government bond yields mean higher costs for companies and consumers to borrow money. A raise in interest rates shouldn’t come as a surprise to anybody, so many analysts believe this is already priced into valuations. One thing is for sure, we are looking forward to watching this play out in the news, on social media, and for investors.