Note: This post is an excerpt from Gould Asset Management’s Economic and Market Review for the Second Quarter of 2018. The excerpt is posted here for the benefit of our blog subscribers.
US Stocks Move into Positive Territory for 2018 as Market Volatility Subsides
After a volatile start to 2018, US stocks found their footing in the second quarter, rising 3.4% on the period, as measured by the S&P 500 stock index. Most of the gains occurred in May, and US stocks now have risen 2.7% year-to-date. Markets were buoyed by positive earnings momentum, supportive economic data, and a de-escalation of tensions between the US and North Korea. Markets, however, showed they are vulnerable to escalating trade threats, as the Trump administration moved ahead with tariffs on imports from China and several other countries.
Market volatility was mostly subdued in the second quarter after a rather tumultuous start to the year. The VIX implied volatility index was above 20 at the start of April (near its long-term average), however it began trending downward soon thereafter, hitting a tranquil 11.6 in early June, before rising to about 16 at quarter-end. Concerns about the US quitting the Iran nuclear accord and the potential for a US-China trade war had surprisingly little impact on measures of investor fear.
The best performing sectors over the quarter were energy (up 13.5%), consumer discretionary (up 8.2%), and technology stocks (up 7.1%). Gains in the consumer discretionary sector were driven by robust retail sales, which grew by over 6% year-on-year in May. Recent gains in wage growth (which had long been stagnant) appear to be having a positive impact on consumer spending, making the consumer discretionary sector (up 11.5% year-to-date) the best performing sector so far in 2018. For more information on the energy sector rally in the second quarter, see the alternative investment section near the end of this market recap.
Mid and small cap US stocks (up 6.0%) outperformed large caps in the second quarter, thanks in part to a strong US dollar that created headwinds for large multinational US companies. The less favorable exchange rate causes multinationals’ foreign profits to be lower when expressed in terms of US dollar corporate earnings. Year-to-date, mid and small cap US stocks have risen 5.9%, ahead of the 2.7% return on large cap stocks.
International Stocks Succumb to a Strong US Dollar and a Deteriorating Trade Outlook
If not for the strong US dollar (up 5.6%), international developed stocks would have posted positive returns in the second quarter. Taking currency translation into account, however, the MSCI EAFE index slid 1.0%, putting year-to-date returns for 2018 at -2.4%. In the Eurozone, the UK was among the best performers, as markets got a boost from the Bank of England’s decision to postpone what would have been its first rate hike since the 2008-2009 financial crisis. Italian stocks, on the other hand, performed poorly amid renewed political uncertainty that pressured Italian banks, in particular. Japanese markets also declined amid concerns the US might impose tariffs on Japanese auto exports.
Emerging markets equities posted some of the largest declines globally in the second quarter, with the MSCI Emerging Markets index falling 7.9% on the period. This erased earlier first quarter gains, putting year-to-date returns at -6.5%. Market weakness was broad-based among the countries that comprise emerging markets, as both the strong US dollar and protectionist US trade policies proved to be too much to overcome. China was among those hard hit, prompting the central bank to cut the reserve ratio for banks by 1.25% over the quarter in hopes of encouraging lending and supporting economic growth. Brazilian stocks also fell sharply, as a truck driver strike paralyzed the economy and contributed to growing political uncertainty in the country.
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