The first quarter of 2018 was a stark contrast from last year, with almost every asset class in negative territory. In 2017, events that typically move market prices such as war threats, political scandals, rising interest rates, and natural disasters failed to drive volatility higher. What a difference a quarter makes. Suddenly, what was once ignored came into focus for market participants – tightening monetary policy, above average valuations, inflation data picking up, and trade protectionism. Ironically, volatility and market reactions to data are signs of a healthy market. The market correction we experienced in the first quarter was a much needed reprieve. Consistently earning positive returns month over month was an unsustainable path that would have led to frothy, bubble like conditions. Despite recent volatility, we are encouraged by the fundamental underpinnings of the market as corporate earnings and global growth continue to accelerate.
Fixed income markets were not immune to volatility. U.S. bonds returned -1.46% and municipal bonds earned -1.11% as rising interest rates provided a challenging environment for bonds. Citing economic strength, the Federal Reserve raised interest rates for the sixth time since 2015, taking the Federal Funds Rate to 1.75%. The rate hike itself was well telegraphed and expected, but market participants were concerned about the Federal Reserve’s updated projections. Given strong economic data and firming inflation measures, the central bank increased the amount of interest rate hikes expected over the next two years. In addition, the Federal Reserve continues to wind down its balance sheet, which many economists surmise equates to an additional 25bps rate hike. We continue to own high quality bonds and remain below average in duration, which has benefited our portfolio in a rising rate environment.
Global stock markets started the year at a record pace, but lost ground in February and March to finish the quarter in negative territory. U.S. equities finished -0.64%, posting its first negative quarter since 2015. The first three months of the year felt like a tug of war between the bulls and bears. The bulls touted solid global growth, deregulation, and benefits of tax reform while the bears were troubled by trade tensions, higher interest rates, and elevated valuation levels. International markets didn’t fare any better returning -2.04% as trade fears reached Europe and Asia. Emerging markets were the lone bright spot, earning 1.42%. Earnings growth and economic data exceeded expectations and proved to be resilient despite volatility in developed markets. By quarter-end, global valuations retreated down from above average levels and are now trading in-line with historical averages.
Economic fundamentals remain sound as global economies continue to enjoy synchronized growth. The U.S. economy accelerated closer to 3% GDP, up from 2% levels. With the passage of tax reform (lower corporate and individual tax rates), we expect the momentum to continue for the rest of the year. The leading economic indicators we follow remain healthy, but future growth could be challenged as trade matters take center stage. U.S. and China continue to play tit-for-tat with tariffs. If retaliations escalate, it could hamper growth not only for the parties involved, but globally as well. We hope to see cooler heads prevail, leading to trade deals getting negotiated. In the long-run, there are no winners in a trade war.
Topic of the Quarter: Now and Then
By Dave Goetsch
Dave Goetsch, Executive Producer of The Big Bang Theory, reflects on his investment experience in the recent market downturn and contrasts his new perspective with memories of the 2008-2009 financial crisis.
Seeing all the recent headlines about the sudden downturn in the stock market has transported me back to February of 2009, when I was close to despair. It’s striking how different I feel now.
In February 2009, the stock market was down around 50% from its high, and everyone seemed to feel like the sky was falling. I was familiar with this state of panic because my relationship to the financial markets was that I didn’t trust them. They were always going up and down in ways no one could predict, and I couldn’t trust those folks who said that they could anticipate what was going to happen. So when the market went down, I went down with it—sinking into a depression, knowing there was nothing I could do.
What a difference nine years make. I haven’t changed because the stock market rebounded. I changed because I learned that there was a different way to think about investing. I was right not to trust those people who thought they could predict what was going to happen in the markets, but I was wrong in thinking that there was nothing to do. I’ve learned that I can have a great investment experience if I just accept a few simple truths.
I have to understand the uncertainty of the market.
The stock market, as measured by the S&P 500 Index, has returned about 10% per year over the last 90 years,1 but there are very few individual years in which it has ever actually returned that amount. In fact, how many of those 90 years do you think the S&P 500 was up more than 20% or down more than 20% for that year? The answer is 40. Astounding, right? I wish somebody had explained that to me decades ago. Then I would have known to look at stock market returns in terms of decades—not years, months, days, or hours. I would understand that so many of those articles and cable news pieces are just noise, designed to keep an audience obsessed and unsettled.
In order to be a long-term investor, you have to have a long time horizon. This can be hard to remember when you’re being assaulted by noise, but if you can stay strong, the results are stunning. By results, I don’t mean the investment returns, which hopefully are good. The return I’m talking about is how I feel every day. I worry less—not just about the future, but also about the present. Of course, I know that there are no guarantees when it comes to investing, but I feel like I’m going to be okay. I have a plan. There’s no way I could’ve done this without a financial advisor. I needed someone who could not just talk me through what my asset allocation should be, but also help me work through how I felt about investing and what exactly I could do to change my perspective.
I was a mess nine years ago. Now, my outlook is totally different. The markets haven’t changed; they still go up and down. The difference is, I don’t anymore.
Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Investing risks include loss of principal and fluctuating value. There is no guarantee an investing strategy will be successful. Dimensional Fund Advisors LP pays Dave Goetsch for consulting services. Dimensional Fund Advisors LP does not endorse, recommend, or guarantee the services of any advisor. The experience of the author may not be representative of the experiences of other individuals. All expressions of opinion are those of the author and are subject to change. This content is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.