As January began, it was clear that 2017 was going to be a tough act to follow for investors. It was a year marked by historically low volatility, essentially unchanged Treasury yields, and a straight up trajectory for equity markets, and as such, it seemed unlikely for this Goldilocks scenario to repeat itself again in 2018. Yet, as January came to a close, it appeared that the train had actually picked up steam, as U.S. stocks posted their best month of January since the late 1990s and bonds remained range bound, despite changes at the Federal Reserve and stronger rhetoric globally on the need to tighten policy as we move later in the cycle.
In early February, however, that all changed. Volatility returned to both the bond and stock markets, as an inflation scare in wage growth data from January led to concerns of an acceleration in interest rate hikes, and bets made against a spike in volatility only proved to increase that volatility as investors moved for the door. Follow that with escalating tensions between China and the U.S. on the Trump Administration’s adoption of protectionist tariffs – met swiftly with Chinese retaliatory measures - and concerns about the sustainability of the stunning run in technology stocks, and investors were left wondering at the end of the quarter if the bulls had enough fight left to move the markets forward.
Breaking down the quarter, the S&P 500 Index lost -0.8%. Interestingly, traditional defensive sectors failed to provide protection to investors in this particular period, as telecommunications, real estate, and utilities sectors all underperformed the broad benchmark, continuing the trend of underperformance for yield substitutes over the last several quarters. Technology and consumer discretionary were the only two sectors that posted gains for the quarter, as growth names once again outperformed value. The spread for the first quarter between the Russell 1000 Value and Russell 1000 Growth indices was a whopping 425 basis points. A strong return for small caps in March led to outperformance in the quarter relative to large cap stocks.
International developed stocks were modest underperformers when compared with U.S. stocks in the quarter, but were buoyed by a weaker U.S. dollar. U.K. stocks were significant laggards, even as a deal outlining the transition from the current relationship between the U.K. and European Union was inked during the quarter. Small cap stocks in the international developed markets also outperformed, as they did in the U.S. Emerging markets equities were one of the few bright spots in the quarter, as global growth expectations have remained strong, and a subdued dollar and relatively attractive valuations have continued to create a supportive environment for investors to move capital into this asset class.
Within the fixed income markets, performance was mixed over the course of the quarter. Expectations for bonds in the current rising rate environment remain muted, and while the volatility experienced in the equity markets pushed some participants back to the bond market, this brief flight to safety was more than offset by the impact of higher rates. Investment grade credit underperformed government issues in the quarter, while high yield corporates outperformed the investment grade universe. Municipal bonds continued to keep pace with the taxable part of the market, despite lower tax rates for many Americans following last year’s tax reform passage.
Source: Bloomberg and Morningstar
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