Diversified portfolios generated solid returns in the first quarter as U.S. and foreign stock indices registered strong gains. The S&P 500 gained more than 6% while the MSCI ACWI ex U.S., a broad index of foreign stocks, returned nearly 8%. Bonds also registered positive returns as yield levels were stable across most maturities during the quarter.
The robust gains in U.S. stocks in the first quarter reflected a continuation of the strong returns recorded in the final quarter of 2016. Most of the first quarter gains occurred early in the quarter and were generally attributed to investor optimism that the Trump administration would deliver substantial tax cuts and increased infrastructure spending. Investors’ enthusiasm waned, however, in March following the inability of the Republican-controlled House of Representatives to pass the healthcare reform bill. U.S. stocks were down about 1% over the final two weeks of the quarter.
Within U.S. stocks, growth stocks outperformed value stocks and large company stocks outperformed small company stocks. Technology stocks were particularly strong performers, led by Apple, which gained 24% for the quarter.
Foreign stocks benefitted from modest improvement in economic growth in Europe and a relatively uneventful quarter on the political front in most regions of the world. U.S. investors in foreign stocks benefitted from gains in local stock markets and from foreign currency appreciation relative to the U.S. dollar. The weaker dollar also provided a boost to emerging market stocks, which gained more than 11% per the MSCI Emerging Markets Stock Index.
U.S. bonds registered moderate gains for the quarter. The Barclays Aggregate Bond Index gained 0.8% while the shorter maturity Barclays 1- 5-year Government/Credit Index returned 0.6%. Municipal bonds outperformed taxable bonds during the quarter after underperforming in 2016. The Barclays 1-5 Year Muni Bond Index returned 1.2%. Taxable bond yields were little changed for the quarter even though the Federal Reserve raised short-term interest rates in March for the second time in four months. While bond yields typically rise when the Fed raises short-term rates, the reaction to the March rate increase was muted as bond investors remained unconvinced that economic growth and inflation are poised to accelerate.
Commodities, as measured by the Bloomberg Commodity Index, were down about 2% for the quarter, as declines in oil and natural gas prices more than offset price gains in industrial and precious metals and grains.
A salient characteristic of the current market environment is the unusual relationship between the level of global economic uncertainty (high) and the level of market volatility (low). As a general rule, investors prefer more stable investments such as bonds and cash during periods of high uncertainty. Consequently, periods of high uncertainty are typically characterized by periods of high stock market volatility (bigger daily swings in the major indices) and, often, declining stock prices.
The current period is an exception to the rule. The level of global economic policy uncertainty is quite high as measured by an index created by professors at Stanford and the University of Chicago. At the same time, stock volatility is quite low. In fact, the S&P 500 had only one daily drop of more than 1% during the entire first quarter. This is highly unusual.
What might explain this unusual environment of high global economic uncertainty and low stock market volatility? And what are the implications for investors? These are important questions to consider since the implications for near-term stock returns are very different depending upon the cause of the divergence.
An optimistic interpretation is that investors are appropriately filtering out much of the uncertainty and focusing instead on the relatively healthy underlying economic fundamentals – for example, corporate profits are expected to continue growing and the job market is firm. This interpretation, if correct, suggests that stocks should continue trending higher unless a monumental shock such as the breakup of the European Union occurs, and further suggests that, absent such a dramatic event, investors should continue focusing on the generally positive underlying economic fundamentals.
A more pessimistic read is that investors are becoming overly complacent to the risks in the market. Over the past year, two major events, Brexit and the election of Trump, have turned out to be false alarms for investors since predictions of big market declines accompanying these developments were off-the-mark. Given this recent experience, investors may have started believing that the stock market is impervious to policy surprises. This interpretation, if correct, suggests that the stock market is vulnerable to a decline. If investors are complacent to the risks, a return to more normal levels of volatility could rattle unsuspecting investors, leading to increased stock sales and downward pressure on prices.
There’s likely some truth in both explanations. Investors are generally well-served by focusing on the underlying fundamentals rather than the twists and turns of policy developments and, as noted, the current fundamentals are reasonably solid. At the same time, the level of complacency among investors seems high. In this environment, it is especially important to maintain a disciplined investment approach. With history as a guide, stock market volatility is unlikely to remain at the current low levels for much longer.
Written by Rich Golinski, CFA, Principal & Chief Investment Officer; [email protected]
|Index||Market||Year-to-Date as of 3/31/17|
|Standard & Poor’s 500||Large Co. U.S. Stocks||6.07%|
|Russell 1000 Value||Large Co. Value U.S. Stocks||3.27%|
|Russell 2000||Small Co. U.S. Stocks||2.47%|
|MSCI All-Country World ex U.S.||Foreign Stocks||7.86%|
|Barclays 1-5 Year Gov’t/Credit||U.S. Shorter-Term Taxable Bonds||0.57%|
|Barclays Aggregate Bond||U.S. Taxable Bonds (Broad-based)||0.82%|
|Barclays 1-5 Year Muni Bond||U.S. Shorter-Term Tax Exempt Bonds||1.20%|
|JPMorgan Global Ex-U.S. Bonds||Hedged Foreign Bonds||-0.37%|
Key economic indicators compiled by Jeffrey Blanchard, CFA, Investment Analyst; [email protected]
Enclosed with this Quarterly Summary are performance reports for your consolidated accounts, portfolio appraisals, and a billing statement. You will also receive a statement(s) from your custodian summarizing your account activity this quarter, which we encourage you to review.
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Data Sources: Morningstar; Econoday; Bloomberg.com
(1) Source: MSCI. MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. MSCI data may not be redistributed or used as a basis for other indices or investment products.
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