1Q17 MARKET OVERVIEW
Markets were unusually calm in the first quarter. The lack of volatility was even more surprising when you consider the rise of equities in the face of political roadblocks that further delayed President Trump’s pro-growth agenda. As attention turns to potential income tax law changes, we can anticipate a more bipartisan approach if any changes are expected to move forward this year.
As we progress further into the year in anticipation of additional interest rate hikes, we will continue to take advantage of diverging market trends by rebalancing to target allocations while maintaining your desired risk level and fulfilling your cash flow needs. This process typically involves harvesting gains or losses in the most tax-efficient manner possible and then re-allocating the proceeds to out of favor asset classes that offer more attractive long-term opportunities such as international equities and bonds. This process is likely to become more interesting and involved in the months ahead as our government tries to reach an agreement on new trade policies and tax law changes.
U.S. Equity Markets
The U.S. equity markets started the year on a positive note; the Russell 3000 advanced 5.7% for the quarter. The post election boost to consumer and business confidence carried over into 2017; however, this optimism was tempered a bit with the health care reform debacle in March. Investors now seem to understand that we need continued economic and earnings growth support rather than just political optimism to move the markets in an upward sloping direction. Fortunately, favorable earnings growth helped stabilize the markets when the Trump administration ran into unexpected legislative obstacles. The most notable earnings strength was in the technology arena which was the top performing sector with a 12.2% gain. Manufacturing also expanded in 17 of the 18 industries tracked by the Institute of Supply Management (ISM), signifying continued growth as overall inventories contracted. The U.S. Bureau of Labor Statistics reported that the unemployment rate ticked down slightly to 4.5% in March as the economy added only 98,000 jobs after solid gains the prior few months. The more positive economic landscape and wage growth gains during the quarter help explain why consumer discretionary stocks also outperformed the overall market.
International Equity Markets
International developed equity markets excelled with an impressive 7.3% quarter gain for the MSCI EAFE. As U.K. prime minster Theresa May triggered Britain’s two-year withdrawal from the European Union, the local markets decided to focus less on the unknowns and more on the strengthening eurozone economy. After experiencing two recessions in the past ten years and many earnings disappointments, companies are finally delivering on higher expectations. This positive news along with the strongest business survey data in six years and shrinking unemployment rate provide higher hopes for GDP growth in the 2% range. What is even more impressive is that the EAFE return exceeded the U.S. market broad market return with only a third of the technology exposure that exists in the S&P 500. After experiencing difficultly since the U.S. presidential election, emerging markets shrugged off concerns with a healthy 11.5% MSCI EM gain. Given Trump’s mixed results in his first 100 days in office, it is not surprising that the fears surrounding rising interest rate pressure, dollar strength and the potential impact of new protectionism trade laws subsided and lifted EMs long-term prospects. After four consecutive and painful years of underperformance relative to the U.S. markets, both developed and undeveloped international markets continue to look much more attractive from a valuation perspective.
Fixed Income Markets
Safety-minded investors experienced a modest rebound to start the year; the Barclays Aggregate was up 0.8% for the quarter. After the Fed raised rates for the third time in ten years, the 10-year Treasury retracted from 2.45% on December 31 to 2.40% on March 31. Given the 5 basis point overall yield decrease, longer dated maturities posted more positive returns since their existing bonds became more attractive compared to newly issued securities. The Barclays US Government Long posted a 1.5% quarter gain, Intermediate 0.5% gain and Short 0.3% gain. In the international fixed-income arena, the JPM Non-US Unhedged rose 2.0% in the quarter with the help of a softening U.S. dollar. The Barclays Municipal staged a nice recovery gaining 1.6%. Given the increased uncertainty of the expected tax law changes and continuation of the punitive investment tax associated with our existing health care system, investors re-focused their bets on the likelihood that Municipal bonds will continue to provide a tax advantage moving forward.