Q1 2018 Market Commentary
Equity markets charged ahead during January before falling into correction territory in early February. The correction was driven by technical factors and an overreaction to a spike in wage inflation during January. Markets recovered slightly in February before tariffs announced by the US and China sparked another sell-off. Underlying economic data remained strong despite the surge in market volatility. Global PMIs and strong employment data showed that the broad-based growth story is still intact. Additionally, earnings were able to meet lofty expectations and consumer and business confidence remained high. On the monetary policy front, the US and Canada continued to raise rates while their global peers kept easy money policies in place. Overall in the fixed income market, rising inflation expectations led to higher bond yields. The NASDAQ was the only major US index with positive returns for the quarter. Global markets as measured by the MSCI ACWI fell 1.41%. International bonds returned 3.62% while domestic bonds posted a negative 1.46% return.
The passage of December tax reforms and robust economic reports drove the stock market to new highs to begin the year. Consumer and business confidence continued to hover near highs and Q4 GDP was revised upwards to 2.9%. A report showing elevated wage inflation in January incited fears that inflation and a fast-moving Federal Reserve could destabilize the bull market. Those fears sparked a rapid sell-off in equities, and the surge in volatility forced popular inverse-VIX strategies to unwind. The markets entered correction territory, down 10% from recent highs, in February and struggled to recover due to trade tensions related to NAFTA and US and China relations. Despite the surge in market volatility, the Fed moved forward with its first rate hike of the year citing rising inflation and stable economic growth as the reasons for the decision. Technology and consumer discretionary were the top performing sectors. Rate-sensitive sectors like utilities, REITs, and telecoms were the worst performing sectors during the quarter. The S&P 500 lost 0.76%, the DJIA fell 1.96%, and the NASDAQ returned 2.59%.
Overall, global market slightly underperformed the US based on the MSCI ACWI Ex USA index return of -1.08%. The Eurozone held up better during the correction than the US. Investors were less concerned by trade war fears and focused more on positive earnings growth and economic reports. The European Central Bank reiterated that it will not begin raising interest rates until the current quantitative easing program is scheduled to end later this year. Other than the UK, all major European economies posted positive economic data. Earnings were helped by strong consumer spending activity and more stabilized currency levels keeping inflation in check. Overall, the UK FTSE 100 lost 4.81% and the eurozone fell slightly with the MSCI EMU losing 0.39% for the quarter. Japan was the worst performing developed market during Q1. An increase in protectionist rhetoric from the US and China sparked fears that the fragile growth trends in Japan’s export-driven economy may reverse course. Additionally, heightened volatility led to a spike in the demand for the Yen which was a headwind to price recovery in March. For the quarter the Nikkei 225 index lost 5.1%. Emerging markets continued to outperform driven by global growth tailwinds, stable macroeconomic data and higher commodity prices. The MSCI EM index returned 1.47%. Brazil and Russia showed significant outperformance returning 12.36% and 9.38% respectively. China struggled to cope with rising trade tensions and a pullback in consumer activity and real estate investing. The MSCI China index returned 1.82%. India was a major laggard during the quarter posting a loss of 6.95%.
In the US, rising inflation expectations and the Fed rate hike overcame the demand for bonds during the market correction. As would be expected in a rising rate environment, shorter-dated bonds outperformed longer dated issued. The Barclays Short Treasury index returned 0.32% while the Intermediate Treasury index lost 0.75% and the Long Term Treasury index lost 3.29%. Because of the inverse relationship between bond prices and interest rates, the expectation of multiple Fed rate hikes, rising inflation expectations, and the strong underlying economy reined in demand for bonds. International bonds outperformed domestic. With many central banks still making asset purchases, investors were more eager to purchase bonds during the February correction. The Barclays Global Agg Ex US index returned 3.62%. A depreciating US dollar, rising commodity prices, and positive global GDP reports helped boost local currency emerging market bonds. The Barclays EM Local Basket bond index returned 3.94% for the quarter.
Commodities and gold held up well during the quarter. The asset classes have historically benefitted from the market environment that persisted during the last two months of the quarter. Commodities benefitted from rising inflation expectations and projections for growing global demand. Gold prices benefitted from rising volatility, a falling US dollar, and geopolitical fears. The S&P GSCI index returned 2.19% and gold spot prices rose 2.54%. Publically traded real estate struggled to cope with rising interest rates which eat into profits and borrowing costs. The Dow Jones US Real Estate index fell 5.91%. The issues were felt on a global scale as shown by the NAREIT All Equity REITs index falling 6.66%. Oil prices benefitted from stable prices and reports showing that demand has started to move more in line with supply, and the expectation that OPEC will maintain production cuts through 2018. Additionally, geopolitical tensions, inflationary pressures, and a weaker US dollar served as a backstop for oil prices. WTI prices rose 7.45% during the quarter. Hedge funds benefitted from rising market volatility, lower correlations, and diverging global interest rates. The HFRI Multi-Strategy index returned 1.97% for the quarter.