ECONOMIC SUMMARY
Economic growth revised upward. Economic growth in the U.S. was revised upward to a rate of 2.9% in the fourth quarter of 2017. The slight acceleration in real Gross Domestic Product (GDP) growth came from stronger numbers in consumer spending and rising inventories. We expect economic growth to increase in the first half of 2018 due to tax cuts with a possible slowdown in the second half of the year.
Continued strong job growth. The U.S. economy added 313,000 jobs in February, almost 100,000 higher than expected and accompanied by an upward revision to the previous two months’ number by 45,000. The unemployment rate remained at 4.1% with an increase in the participation rate to 63%. Wage growth increased 2.5% year-over-year, faster than last month. We are reaching full employment in our economy, which could limit U.S. economic growth in 2019 and beyond.
Corporate profits show continued strength. The 4Q17 corporate earnings numbers are almost complete, and corporate profits show a 21.4% year over year growth rate. Sectors showing particular profit strength include materials, energy, industrials and technology. Almost 67% of companies are beating revenue estimates and 75% of companies have beat on earnings. Many companies have announced one-time tax charges from tax reform and have increased their profit guidance for 2018.
Inflation shows gradual firming. While the headline consumer price index (CPI) increased slightly to 2.2% year over year, the core measure (less food and energy) was flat at 1.8%. Increases in gasoline and rent were the major reasons for the increase. Wage growth is showing signs of increasing which is causing investors some concern that rates will go up faster than expected. The Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) index, which covers a wide range of household spending items, increased slightly by 0.2%.
The Federal Reserve raised interest rates again in late March. The Federal Open Market Committee (FOMC) increased the federal funds rate by 0.25% at their meeting last week. The Fed funds rate projections denote three rate hikes this year, in keeping with expectations. The Fed also increased their expectations from two rate hikes this year to three due to stronger growth expectations.
EQUITY MARKET SUMMARY
The S&P 500 index fell -2.54% in March, finishing -0.8% year-to-date (YTD). After starting the year off with a bang in January, U.S. large-cap equities were down 0.8% through the end of March as investors absorbed the implications of trade tensions, higher interest rates, firming inflation, and fiscal stimulus. U.S. small-cap equities did only marginally better, down 0.1% YTD, perhaps because of their smaller exposure to global trade dynamics. All the major equity asset classes showed a loss for the month. The Dow Jones Industrial Average (DJIA) fell 3.59% for the month while the NASDAQ Composite fell by 2.79%. The selling was synchronized globally as developed foreign markets as measured by the MSCI EAFE index decreased by 1.89% for the month; emerging markets stocks, as measured by the MSCI Emerging Markets index, decreased by 2.00% for the month. EM is still a bright spot, up 1.5% YTD, due to improving and more resilient fundamentals in both economic and earnings growth.
Consensus forecasts are indicating S&P 500 earnings growth should top 18% in Q1, and since the end of 2017, Q1 estimates have risen 5.5%, and the full-year estimate has risen 7.3%. This Goldilocks scenario suggests investors should remain bullish for the longer term despite recent volatility that is not atypical, as stocks have historically trended down the first nine months of midterm election years before rallying strongly in the fourth quarter. The average Q4 return in the S&P in midterm years is 7.9%, with small caps following a similar pattern. Moreover, midterm election-year corrections typically represent a great buying opportunity, with stocks up one year later from their low every time since 1962 by an average of 36%. The S&P has not declined in the 12 months following a midterm election since 1946, regardless of which party wins.
Return of volatility in the first quarter. Over the course of the past three months, the S&P 500 experienced six trading days of +/-2% moves, juxtaposed to 2017 when we saw zero such moves, which has resulted in a bumpier ride for equity investors.
LARGE CAPS OUTPERFORM SMALLER CAPS YTD:
| Dow Jones | -1.96% |
| S&P 500 | -0.76% |
| Russell Midcap | -0.46% |
| Russell 2000 | -0.08% |
| NASDAQ | 2.59% |
GROWTH OUTPERFORMING VALUE YTD :
| Large Cap | 1.93% vs. -3.58% |
| Mid Cap | 2.17% vs. -2.50% |
| Small Cap | 2.28% vs. -2.61% |
Best performers: Year to date, the Technology sector has the best returns at 3.5% followed by Consumer Discretionary at 3.1%. While both sectors have benefited from reasonable valuations, the growth expectations of Technology and Consumer Discretionary have increased from an improvement in consumer sentiment over the last several months.
Worst performers: Telecom (-7.5%) and Consumer Staples (-7.1%) have had the worst negative YTD returns due to pricey valuations and interest rate sensitivity due to high dividend payout ratios. When rates rise, and investors can get better yields in short term bonds with less risk, these stocks suffer.
FIXED INCOME SUMMARY
The 10-year Treasury yield fell below 2.8% for the first time in 7 weeks. This sizable decrease in yield (resulting from an increase in bond prices) resulted from investors buying Treasuries heavily as equities sold off. The wage growth that earlier spooked the markets has abated somewhat. The Fed is likely to continue to tighten interest rate policy as it considers more than three rate hikes this year to stem increasing expectations of inflation.
The yield curve continues to flatten. With the short end of the curve increasing due to Fed rate hikes, and the long end of the curve coming down due to low expectations of inflation, the spread between 2-year and 10-year notes is below 50 basis points, the lowest since October 2007. We are not expecting the curve to invert (short-term rates higher than long term) as this could signal a recession in the future.
U.S. fixed income investment performance is negative year-to-date except for cash (returning 0.3%). The Barclays Aggregate index dipped by 1.46% YTD and the Barclays High Yield declined by 0.86%. Municipal bonds declined by 1.11% so far for 2018 and U.S. Corporates have declined by 2.32% so far. Internationally, the Euro Aggregate has shown an increase of 3.17%.
Year-to-Date Index Returns (as of 3/29):
| Index | YTD Returns |
| Barclays Aggregate | -1.46% |
| Barclays Euro Agg | 3.17% |
| Barclays U.S. High Yield | -0.86% |
| Barclays Municipal | -1.11% |
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