Q1 2018 RECAP
abril 3, 2018
1st QUARTER’S FAST START DID NOT LAST! GLOBAL EQUITY MARKETS LOWER. U.S. BOND YIELDS TO-THE-BRINK. VOLATILITY ROSE, REMAINED HIGHER. CONCERNS: TRADE TARIFFS & FED. FED FUNDS RATE UP 25 BPS.
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U.S. equities ended nine quarter win streak. Treasury yields higher. Dollar declined. An eventful 90 days in both principal asset classes. Bond yields, seemingly suppressed most of 2017, floated higher from the start. In January, the yield on the 10-year note rose 30 basis points (12%). Part 2 of the run-up, in February, with the benchmark near 3%, and psychological level. Five weeks into a new year, yields were significantly higher. It changed the market’s perspective. Caution was in, complacency out. Afterwards, the main reason for the intense selling pressure, a more pronounced inflationary picture, proved premature, thus lowering bond yields. In March, the Federal Reserve lifted the short-term rate one-quarter of one-percent. The consensus view. However, despite holding the previous position on rate increases for 2018, the central bank upped expectations going forward (more hikes) the next 2 years. That, seemed to change the calculus. All of a sudden the Fed, at least on paper, was forecasting a more aggressive rate path. With inflation still below their target, a reversal from negative to positive real rates helped redirect the market’s positioning from extremely short long-dated Treasuries. The quarter’s final week saw strong buying interest, especially in 10 and 30 year debt, with securities dipping below 2.75% and 3%, respectively. So, instead of the 10-year threatening 3%, and perhaps a more profound change in investors views, the quarter closed with the 30-year long bond below an important marker.
The story in equity markets was a mirror-image of bonds. All began with a flourish. Following a superlative year in both returns and record low volatility, U.S. stocks came into the New Year flying high. And for the 1st month the flight pattern did not veer. Then, higher bond yields (competition for stocks) could no longer be ignored after spiking higher. Stocks tumbled in short order, a decline of more than 10% in less than 10 days (record speed for a correction). The 2nd-half of the opening quarter saw stocks playing more defense than offense. The long list of concerns centered on political issues which over time had seeped into the economic side. The economy, strong and getting stronger, as per the Fed, could be partially neutralized down-the-road if trade tariffs escalate. That is the outlier, but is a fear. For now, the degree and magnitude of potential tariffs are unknown. Still, that did not prevent markets from reacting to a potential worst-case scenario. Though it is not the consensus view, markets move to their own rhythm and psychology. Even the Fed weighed-in to the possibility, indicating further trade action could have an impact on policy. Left unsaid by chair Powell is if trade becomes a consumer tax, inflation would rise and may therefore directly affect Fed actions in a way that almost assuredly would be negative. The year opened with trade tensions limited to NAFTA, but took on a broader meaning in March. Based on the current rhetoric anything is possible, including a breakthrough that splits the difference between multiple parties to reach an amicable outcome. But that possibility is less likely today than a month ago.
In numbers, U.S. markets climbed a couple of thousand points before the aforementioned correction. From there, volatility zoomed, prices dropped, later zig-zagged, and investors became much more risk-averse. That summed-up the quarter’s second-half. Price swings matched mood swings. What became a repetitive pattern was heavy selling the final 2 hours of sessions. More often than not, days in deep red were marked this way. In contrast, positive days saw no follow-through. In all, the month of March did not come close to matching its historical average – the S&P 500 index lost almost 3%, and down more than 1% for the quarter. The best attribute during the February-March slide was the market’s penchant for closing each week on a strong note. Almost without exception, Friday’s found buyers at lower prices. How long that continues is in question with tariff talk in the headlines, and 1st quarter corporate earnings, the linchpin in the fundamentals story, still on the horizon.