Sell in May and go away? Not so in 2018, as U.S. stock markets have rallied strongly over the past 3 months. The S&P 500 gained 7.10% over that time period, recouping its losses from early in the year and even hitting a new all-time high. International and emerging markets have not fared as well, due to ongoing trade disputes and currency crises in Turkey and Argentina. Both the MSCI EAFE and MSCI Emerging Markets are roughly flat since May. Thanks to ongoing economic strength in the U.S., the Federal Reserve is all but certain to raise interest rates at its upcoming September meeting.
It was a strong first half for the U.S. economy with 2nd quarter GDP coming in at a 4.1% annual rate. Solid growth coupled with the boost from tax legislation are supporting another standout earnings season. Second quarter profits for large cap companies are expected to be up more than 20%. Stellar corporate performance has supported the stock market’s recent advance despite continued worries about trade policy and rising interest rates. In fact, the S&P 500 rose 3.72% last month and is just shy of January’s all-time high. International markets were better in July with the MSCI EAFE and MSCI Emerging Markets up 2.46% and 2.20%, respectively.
Despite continued stock market volatility and increasing risks surrounding trade policy, underlying economic growth in the U.S. looks solid. The Atlanta Federal Reserve is projecting just over 4% GDP growth for the 2nd quarter. Equities have slowly moved higher since their correction in February, with the S&P 500 now up a modest 2.65% year-to-date. Small cap stocks have been the standout though, rising 7.66% over the first half of 2018. The Federal Reserve raised its key federal funds rate again after its June meeting, and is projecting one to two more increases for the duration of the year.
After bouncing around between its 50 and 200-day moving average for about six weeks, the S&P 500 finally broke out of that trading range in early May. Momentum continued throughout the month with large cap stocks gaining 2.41%. Down the cap scale fared even better, with small cap equities rising an impressive 6.07%! A firming U.S. dollar and less sensitivity to global trade are often cited as catalysts for recent small stock outperformance. The aforementioned dollar strength, however, was a headwind for foreign assets. International and emerging stocks fell 2.25% and 3.54%, respectively, in May.
QUARTERLY MARKET COMMENTARY : First Quarter 2018
John Pierpont Morgan, best known today from the bank that bears his name, was one of the most important financiers of the late nineteenth and early twentieth centuries. Due to his influence, he was regularly asked for his opinion on what was in store for the stock market. Short-term market movements are notoriously difficult to predict, so Mr. Morgan resorted to a pithy yet proper response – “It will fluctuate.” True indeed, especially for the 1st quarter of this year, which has been characterized by quite a bit of fluctuation. Already there have been 23 days in which the S&P 500 moved greater than one percent, compared to just eight such days in all of 2017. Also, stocks experienced their first 10 percent correction since February 2016. On average, declines of that magnitude happen nearly once a year. It has been an uncomfortable start to be sure, but given that 2017 set records for its lack of volatility, 2018’s market action may be better described as a return to normalcy, rather than an omen of something more sinister to come. Volatile markets typically don’t turn into prolonged bear markets absent material economic weakness, which we don’t believe is currently the case.
It is safe to say the market was still in a corrective phase last month. Whether it was renewed fears surrounding future trade policy, or investor anxiety about technology darlings Facebook, Amazon, and Tesla, stocks continued to experience elevated levels of volatility. As March drew to a close, the S&P 500 had declined 2.54%, and the technology-heavy NASDAQ was off 2.79%. Somewhat surprisingly, the small stocks in the Russell 2000 held up well, actually gaining 1.29%. New Federal Reserve Chair Jerome Powell hosted his first meeting, which went largely as expected. The federal funds rate was increased another quarter percentage point, with a forecast of two to three more hikes through year-end.
RYAN PATTERSON, CFA, CFP®
CHIEF INVESTMENT OFFICER
If you watch the financial headlines at all, you have likely picked up the sense of “Panic!” that has dominated the last few weeks’ reporting about the stock market. Words like “tank,” ”crash,” and “meltdown” have picked up frequency in the press. We suspect the question has crossed the minds of our clients as to what L&W’s attitude is during recent weeks, so I wanted to share with you a quick synopsis of what we’ve been discussing in our Investment Committee meetings during the past 6-8 weeks.
It has to end eventually. The S&P 500 fell 3.69% in February, the first month of losses since way back in October of 2016. Rising interest rates may have been the proximate cause of the pullback, but after 15 straight months of winning, the market might simply have been due to take a breather. From their highs on January 26th, stocks did drop just over 10%, marketing the first official “correction” since early 2016. This pushed the S&P 500 into negative territory for the year temporarily, before a late-month rebound recovered some of the losses. The 10-Year Treasury yield ended February at 2.90%, the highest since 2013.
Markets kept on rolling in January as the S&P 500 gained 5.73%, the 11th best start to a year since 1950. In general, good Januaries foreshadow good calendar years overall. In 9 out of the 10 instances where January market returns were better than 2018’s start, stocks continued to rise for the duration of the year. Emerging market equities were hot as well, having gained 8.33% already. If there were any weakness to be found, it was in fixed-income securities. Rising interest rates took their toll on bonds, and the Bloomberg Barclays Aggregate Bond Index, composed of investment-grade U.S. bonds, fell 1.15% last month.
A good December capped off a great year for stock markets. In fact, thanks to last month’s 1.11% rise, the S&P 500 actually provided positive performance for all 12 months of 2017! International and emerging markets were similarly consistent, with only one down month on the year for each. On the domestic policy front, President Trump signed sweeping tax legislation, which should boost corporate earnings in 2018. Also, the Federal Reserve raised the federal funds rate another quarter point to its new range between 1.25 – 1.50%