2018: FIRST QUARTER IN REVIEW

Michal Emory, CFA, Vice President & Chief Investment Officer, and Eli Sallman, CIMA® , CFP®, Vice President & Investment Officer – Portfolio Manager

The first quarter of 2018 began with strong market gains. The tech-laden Nasdaq led the way by the end of January, posting a monthly increase of almost 7.40%, followed by the large caps of the S&P 500 (5.62%) and Russell 1000 (5.39%).

The employment sector remained strong, with 239,000 new jobs added in January and average hourly earnings climbing 0.3%. Consumer prices rose 0.5% in January, while personal income increased 0.4%. The trade gap continued to widen, which has proven to be a focal point of the current administration. Nevertheless, consumer confidence in the economy increased in January with expectations for continued strengthening in the coming months.

Volatility returned to the stock market in February, with each of the benchmark indexes listed here posting notable losses from the prior month. Nasdaq, while down, fared better than the large caps of both the S&P 500 and the Russell 1000. Investor concerns over rising inflation and interest rates seemed to trigger volatility.

A strong labor report in February revealed a 2.9% increase in average hourly wages over a year earlier, the addition of 313,000 new jobs, and decreasing unemployment insurance claims. These factors combined to prompt investors to conclude that higher labor costs may eat into corporate profits, which might prompt the Fed to raise interest rates at a faster pace.

March was not a good month for the benchmark indexes listed here, except for the small caps of the Russell 2000. Otherwise, each of the indexes closed March in the red, led by the Nasdaq, which was followed by the S&P 500, and the Russell 1000. March brought more concerns for investors with the administration’s imposition of tariffs on steel and aluminum imports and the threat of a trade war with China. Much of the month saw retaliatory threats lobbed across the Pacific.

The first quarter saw only the Nasdaq post modest gains. The S&P 500 fell by 1.22% by the end of the quarter, with the Russell 1000 close behind with a decline of 1.14%. The Russell 2000 managed a very modest decline of 0.4%. Prices for 10-year Treasuries fell by the end of the quarter, pushing yields up by 32 basis points.

Eye on the Months Ahead

Moving to the second quarter of the year, the economy is expected to maintain its course of relative strength. However, if news out of Washington continues to concern investors, market volatility is likely to prevail. Our thought is that most of the volatility and recent downward pressure on stocks is self-inflicted. While the economy, in general, and companies, in specific, are growing at a nice clip, investors are being distracted by the constant barrage of noise coming from Washington and the media.

There are plenty of reasons to be excited about the economy as the effects of the new tax bill are working their way through it. Companies should see a boost to their earnings and cash flows not just from a strong economy but from the tax bill. Families should be seeing a boost, as well, as the lower tax rates put more in their pockets.

With the pullback that we have seen, the stock market no longer looks expensive. As of this writing, the Forward P/E for the S&P 500 was 17.1X next year’s earnings. While that is not cheap neither is it expensive. We continue to see more value in stocks than most other asset classes which is reflected in our continued overweight position to equities. Growth continues to outperform value and we remain overweight growth for the time being.

We continue to overweight Foreign Developed Equity Markets and Emerging Equity Markets. Valuations overseas remain attractive and U.S. returns in Foreign Markets could continue to benefit from the weakening dollar. We have increased our U.S. Small Cap position to a neutral weighting. Between Small Caps underperforming the past couple of years and Small Caps, generally, being less impacted from a potential trade war, now looks to be a good time to increase our positioning in that asset class.

We continue to be underweight U.S. Fixed Income. As the Fed is raising rates on the short-end, the long-end of the yield remains stubbornly quiet. At the start of December 2015 when the Fed started its current rate hike campaign the 2-year Treasury was at 0.93% and the 30-year Treasury was at 2.97%. As of the close of the first quarter of 2018, the 2-year Treasury was at 2.27% and the 30-year was at, wait for it, 2.97%. There can be, and is, many reasons for this flattening of the yield curve. Since rising rates are bad for bond prices, longer maturity bonds have held up relatively better than shorter bonds thus far in 2018.

Despite the noise from Washington and the increased volatility, we remain positive on the economy and stock market.

Certainly, anything can and will happen but we remain vigilant in monitoring our asset allocation and security selection within that asset allocation.

Click here to view or download a printable file of our Q1-2018 Investment Management Update.