1Q18 Market Overview
Volatility returned with a vengeance. The global equity markets started out the year with exceptional returns in January as the markets continued celebrating the benefits of the U.S. Tax Cut and Jobs Act. The tax cut is expected to boost corporate earnings and increase global GDP growth. This optimism quickly faded as attention turned to rising interest rates, inflation concerns and a trade war with China. Before the dust settled, we endured a sharp and painful 10% correction.
As we progress further into the year in anticipation of additional interest rate hikes, we will continue to take advantage of the volatility and diverging market trends. Our rebalancing process will shift towards our target allocations in the most tax-efficient manner possible while maintaining your desired risk level and fulfilling your cash flow needs. Given the pullback in bonds, our rebalancing process should enable us to harvest fixed income capital losses that can be used to offset equity gains in the portfolio to optimize your after-tax returns.
U.S. Equity Markets
After the U.S. equity markets started the year with extraordinary strength, things turned quickly negative at the end of January with the Russell 3000 eventually posting a modest loss of 0.6% for the quarter. Initially, the new corporate tax reform package and public spending plans helped further stimulate corporate earnings forecasts; however, the brightness dulled as protectionism rhetoric tempered expectations. Volatility then spiked as analysts tried to extrapolate the repercussions of trade negotiations with China. Although our trade deficit with China is $337 billion, it is important to work out an acceptable solution for both parties to continue our impressive recovery. On a more positive note, job growth remained strong in the first quarter according to the U.S. Bureau of Labor Statistics with an average monthly gain of 202,000 (up from a 182,000 monthly average in 2017) as the unemployment rate held steady at 4.1%. As companies report current earnings, we anticipate continued positive support and upside revisions which should help stabilize expectations and help the markets regain their footing.
International Equity Markets
International developed equity markets gave back some of their impressive recent gains with a 1.5% loss for the MSCI EAFE. After springing out of the gate in January, International equity returns were mixed with developed markets retreating and emerging markets holding on to modest gains. Eurozone equities were initially supported by favorable economic conditions and stable unemployment, however, concerns shifted to the path of U.S. interest rates and uncertainty surrounding trade tariffs. Japan experienced a similar pattern with more negative returns after factoring in the yen strength. The yen benefited from potential U.S. nuclear program discussions with North Korea and the anticipated reduction in regional tensions. MSCI emerging markets started January with an 8.3% return before ending the quarter with a 1.4% gain. Chinese equity volatility was exaggerated towards the end of March as the focus turned to trade tensions with the U.S. Both developed and undeveloped international markets continue to look attractive from a valuation perspective.
Fixed Income Markets
Safety-minded investors lost ground to start the year; the Barclays Aggregate was down 1.5% for the quarter. After the Fed raised rates for the fourth time in the past year, the 10-year Treasury moved from 2.40% on December 31 to 2.74% on March 31. Given the 34 basis point overall yield increase, longer dated maturities posted more negative returns since their existing bonds became less attractive compared to newly issued securities. The Barclays US Government Long posted a 3.2% quarter loss, Intermediate 0.7% loss and Short 0.2% loss. In the international fixed-income arena, the JPM Non-US Unhedged rose 4.5% with the help of a softening U.S. dollar. The Barclays Municipal lost 1.1% as the market rallied towards the end of March to reduce downward pressure. Given the continuation of the punitive investment tax associated with our health care system, investors are likely to re-focus their attention on Municipal bonds since they will continue to provide a positive tax advantage in 2018.