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Expert Perspective

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Investment e.Perspective

Current Issue | July 26, 2018

It Is No Longer So Quiet On The Western Front

By: David Lewis, CFA, CAIA, Senior Investment Strategist & Oxford Investment Fellow


The first quarter of 2018 was marked by the return of volatility. Although this was not unexpected given the maturity of the bull market, it probably felt a bit more intense to most investors, given the quiescent environment of the prior year.

US equities as measured by the S&P 500 Index experienced the first quarterly decline in more than two years but the unremarkable 0.8% decline doesn’t reflect the winding road it took to get there. The year began with a continuation of strong momentum, as the S&P 500 increased by more than 7% through January 26. This was driven by further signs of global growth and boosted by the $1.5 trillion tax cut, which is expected to help businesses maintain their already robust profit margins.

This enthusiasm waned, however, as fears of rising interest rates sparked a technical correction (decline of more than 10%) over just nine trading days. Non-US markets followed a similar path with a strong start to the quarter followed by sharp reversals. The MSCI EAFE Index was down 1.5% during Q1 while emerging markets offered a modest bright spot (+1.4%).

Within the US market growth outperformed value with the consumer discretionary and technology sectors being the only positive performers in the quarter. The latter was hit sharply in March, however, by concerns about growth prospects and possible regulatory changes, as Facebook became embroiled in a high-profile privacy scandal.

The tax “cut” sliced both ways, however, as concerns about adding fiscal stimulus on top of an already strong economy brought worries about inflation and an attendant rise in interest rates. The 10-Year Treasury Bond was up 34 basis points during the quarter, ending at 2.74%. While this has been a challenge for the broader fixed income market, which was down 1.5% (Barclay’s US Aggregate Bond Index), rates at the short end of the yield curve have also moved up (3-month Treasury Bill is at 1.73%) which benefits any cash positions.

Economic data continues to be positive and we are closely watching the labor market. Unemployment in the US is at 4.1%, which is the lowest level since 2000, and unemployment in the European Union (7.3%) is approaching pre-2008 levels. One byproduct of a tighter labor market are signs of wage inflation. These inflationary pressures are being driven by more than just changing labor supply-demand forces, as 18 states and numerous municipalities raised their minimum wage effective January 1. In addition, on April 1 enforcement will begin for electronic monitoring devices of truck driver logs. Although this has already been adopted by most major trucking companies, at the margin it is expected to exacerbate driver shortages and raise freight costs.

Federal Reserve policy has also received heightened focus in recent months with the strength of the economy and the transition of the Fed Chair from Janet Yellen to Jerome Powell. The Fed raised rates three times in 2017, and announced plans to begin unwinding its $4.5 trillion balance sheet. Interest rates were raised again at the March meeting, and the Fed’s dot plot, which is a forecast of each policymaker’s forward projections, saw a slight increase in rate expectations in 2019 and 2020.

Lastly, it is clear that the camaraderie and sportsmanship from the winter Olympic Games in PyeongChang have not carried over to trade policies. In March the US imposed tariffs on steel (25%) and aluminum (10%) imports, although it ultimately provided exemptions for a large number of trading partners. In addition, in early April the US announced tariffs on about $50 billion of Chinese goods in response to claims of intellectual property theft. The Chinese government has since responded in kind, targeting US agriculture and a number of other industries for a similar dollar amount. It should be noted that this latest round of tariffs has not yet been implemented, and the total dollar amounts are only a small portion of aggregate trade among nations. Still, such economic frictions and the broader uncertainties they create have the potential to increase consumer costs and slow economic growth.

Amid this volatility diversification becomes ever more important. In addition to increasing our exposure to less expensive areas of the market, such as emerging market equities, we continue to pursue private market strategies which can offer differentiated sources of alpha and less-correlated return patterns for our portfolios.

The above commentary represents the opinions of the author as of 4.19.18 and are subject to change at any time due to market or economic conditions or other factors.