Q2 2018: Economic Commentary
Global financial markets posted mixed results during the first quarter of 2018 amid a spike in volatility on concerns surrounding higher interest rates and rising inflation expectations. Meanwhile, the Trump Administration’s tariff announcement on steel and aluminum led to heightened geopolitical tensions with several U.S. trading partners, sparking concerns of a trade war. We present a few highlights from 1Q18 below:
• U.S. equity markets sold off sharply in late January and early February, resulting in the first correction (10% drawdown) since early 2016. Stocks moved mostly higher for the remainder of the quarter in volatile and choppy trade, with large intra-day moves the norm. Despite the volatile environment, the S&P 500, the Dow Jones Industrial Average and the technology-heavy Nasdaq Composite managed to hover near their all-time highs. On the economic front, preliminary estimates indicate fourth quarter GDP slowed slightly more than initially thought due to slower inventory growth.
• Developed international equity markets produced mixed results during the first quarter on worries that a strengthening U.S. economy may lay the groundwork for a more aggressive Fed. Gains came out of the Pacific region, while Europe lagged. On the political front, the populist movement was back in focus as disenchanted Italian voters opted for anti-establishment parties in an election that yielded no outright winner. In the emerging markets, returns were propelled higher by solid performances from China, Russia and Brazil.
• Within fixed income, results were mixed as yields were volatile. The 10-year U.S. Treasury traded up more than 50 bps at one point during the quarter, sharply higher than the 2017 year-end close of 2.41%. Investment grade core U.S. fixed income ended lower, while high yield credit fared marginally better. Municipal bonds edged lower as investor sentiment shifted in the early part of February and the asset class experienced outflows. In the first few weeks of March, buyers returned. Meanwhile, emerging markets debt continued its impressive run after posting strong results in 2017 and unhedged foreign bonds benefited from weakness in the U.S. dollar.
• U.S. real estate declined significantly in the first quarter, while international real estate produced more muted results. Similar to the prior quarter, international real estate broadly outpaced U.S. real estate. Commodities ended the quarter with mixed results. Weakness among natural gas and several industrial metals components, including aluminum, weighed on first quarter results but were somewhat offset by strength in several agriculture components. MLPs came under heavy selling pressure amid FERC’s tax policy revision.
An important lesson from 1Q18:
• The first quarter of 2018 was a good reminder that investors must remain mindful of geopolitical and other event risk and the associated volatility that comes with it. Until recently, investors have enjoyed the best of both worlds, with stocks and bonds rallying in tandem amid record low volatility. One can forget that volatility can return with a vengeance and calm can turn to turbulence in an instant. As a result, it is more important than ever to remain properly diversified. It is our continued belief that remaining patient and adhering to a well-constructed and diversified investment portfolio anchored to your time horizon and goals remains the prudent course of action.
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