From the President’s Desk: Thoughts on the First Quarter

by Donald Gould

After a remarkably calm 2017, stock markets turned volatile in the first quarter of 2018. To give just one example, the S&P 500 US large cap stock index had a daily move of more than 1% on 23 occasions in the first quarter (37% of trading days), compared to only 8 times in all of 2017 (3% of trading days).

Whenever the market gyrates, it’s human nature to want to know why. And while the news offered myriad explanations that we’ll touch upon in a moment, our sense is that some of the volatility is a natural outgrowth of a market that for more than a year created the illusion of a risk-free winning bet.

US stocks followed an almost straight-line climb in 2017, but beginning right after New Year’s Day the rise took on a steeper—and unsustainable—trajectory. Through January 26, the S&P 500 leaped 9%—a 200+% compound annualized rate of return!—a pace that no amount of economic and earnings growth could support. As often happens when an asset price goes vertical, a correction ensued. (For a more spectacular example, consider bitcoin). Over the remainder of the quarter, the market gave back all its gains, finishing down about 1% for the quarter as a whole. For more discussion of February’s sudden market correction, see our blog post, “Stock Volatility Comes Out of Hibernation.”

So to some extent, the volatility of February and March was a natural reaction to a market that had risen too far, too fast. But there’s been plenty else to unsettle investors. Among the most noteworthy:

Tariffs and Trade Fears – President Trump responded to allegedly unfair Chinese trade practices by unilaterally placing import tariffs on Chinese steel and aluminum, and threatening tariffs on other Chinese products totaling $150 billion in annual imports. Markets have taken the news badly, fearing an escalation that depresses global trade volumes and crimps corporate earnings.

Politics – The White House has been a source of instability on many fronts, including rapid turnover; an ongoing Special Prosecutor (Mueller) investigation; the President’s legal travails with Daniels, McDougal, and now Cohen; and frequent Twitter posts that unsettle investors.

Interest Rates – While stocks rocketed upward in January, long-term interest rates followed suit, with the 10-year Treasury note yield jumping from 2.40% to 2.66% in less than four weeks. Meanwhile, with an ongoing push from the Fed, short-term interest rates continue to climb even faster than long-term rates. The consequent flattening of the yield curve, often a harbinger of recession, has spooked some, though as an economic forecasting tool it is far from foolproof.

Facebook and Amazon Under Siege – Two highfliers that accounted for much of the rise in stock market indexes in the past several years came under attack in the first quarter, jangling nerves. Facebook conceded a major breach of customer privacy, exposing the company to both political and regulatory blowback. Meanwhile, President Trump has taken the unprecedented step of attacking the business practices of a major US company—Amazon—whose CEO, Jeff Bezos, also owns The Washington Post.

Heightened Geopolitical Tensions – While bluster on the North Korean front has subsided at least temporarily, tensions with Russia are ratcheting steadily higher in 2018. Strained relations between the world’s two largest nuclear superpowers is bound to make everyone, including investors, a bit nervous.

Any of these items alone could rattle investors. Taken together, they go a long way towards explaining the resurgence in volatility in the first quarter. Note that President Trump is directly involved in all but one of the items listed above. Since the 2016 elections, markets have largely shrugged off Mr. Trump’s unorthodox behavior and even at times embraced him, for example, with the recent corporate tax cuts. But of late, markets seem to react more to the president’s actions.

Good News, Too

Despite the volatility, however, there has been plenty of good news on the economic and corporate earnings fronts. Consumer confidence and spending are both strong, boosting GDP growth. Likewise, the unemployment rate is low and we’re seeing a long hoped-for return to the labor force of some previously discouraged workers. Combine the good news with the worry list above and you get a bona fide two-way stock market, the first in a long while.

Unsettling as these daily bounces are, we counsel perspective and maintaining the long view. Remember that volatility is the norm, while last year’s absence of volatility was the exception. Stocks really are riskier than bonds, and the higher long-term returns we demand (and, historically, have received) from stocks are the compensation for that extra risk.

Also keep in mind that every period has it worries, but over the typical investor’s long-term time horizon, today’s challenges will likely fade into insignificance, replaced by an endless stream of new ones.

For a detailed discussion of the economy, financial markets, and first-quarter investment performance, be sure to see this quarter’s Economic and Market Review.

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