“I’m back baby, I’m back!” George Costanza, Seinfeld (Episode 65, Season 5)
Just when you thought market volatility was a thing of the past, it came roaring back in the first quarter of 2018. After a year of historical market quiescence, when stock market volatility was almost completely absent, volatility returned in the first quarter of 2018. In 2017 the S&P 500 had no days where it finished more than 2% higher or lower. In the first quarter it happened five times (and a sixth time on Monday, April 2). In 2017 there were only eight days the S&P 500 finished higher or lower than 1%. That happened 22 times in the first quarter. This pick up in volatility occurred despite strong economic news (low inflation, low unemployment, and strong economic growth). Some combination of tighter monetary policy, rising interest rates, high equity valuations, and good old fashioned late-cycle market jitters combined to produce financial markets that were significantly more volatile than what we experienced in 2017.
The U.S. stock market, as measured by the S&P 500, declined 0.76%, its first negative quarter since the third quarter of 2015. However, within the U.S stock market some patterns remained similar to 2017. Despite a brief sell-off at the end of March, the Technology sector was the best performing sector for the quarter, up 3.5%. The strong performance by technology stocks led to another quarter of outperformance by growth stocks with the Russell 1000 Growth (up 1.41%) besting the Russell 1000 Value (down 2.83%). Globally, the MSCI-EAFE Index, representing primarily non-U.S. developed market stocks, declined 1.53% in Q1. However, Emerging Market stocks, as measured by the MSCI-EM Index, were a bright spot, up 1.42% through March. Emerging Market stocks have been notable laggards over the last five years, returning only 4.99% annually while the S&P 500 has returned 13.30% over the same time frame.
Fixed Income markets struggled in the first quarter as interest rates continued to rise. The bell-weather 10-Year U.S. Treasury rate rose from 2.40% at the beginning of the year to 2.74% by quarter’s end. More dramatic was the rise in short-term interest rates. The 3-Month LIBOR rate soared from 1.69% at the beginning of the year to 2.31% by the end of March. Over the past year the 3-Month LIBOR rate has doubled, from 1.15% at the end of Q1 in 2017 to the aforementioned 2.31%. This rise in interest rates led to poor performance across a range of Fixed Income markets, with the broad-based Bloomberg Barclays US Aggregate Index falling 1.46% in the first quarter.
Other asset classes that have sensitivity to interest rates also fared poorly in the first quarter. REITs and MLPs both suffered through a very difficult quarter. Parsing the exact reasons behind the poor performance in REITs and MLPs is probably a fool’s errand. Suffice it to say that some combination of high valuations (REITs), concern over the consequences of tax policy (MLPs), and the impact of rising rates all were contributors. Regardless of the exact reasons, it was a difficult quarter for investments that have interest rate sensitivity.
In the last market update we counseled against assuming that 2017’s “Goldilocks” environment would continue into 2018. It only took one month for that advice to look prophetic. Moving forward, it will be important to maintain appropriate portfolio diversification, as we try to do through such strategies such as Reinsurance, Alternative Lending, and Hedge Funds, that have little to no correlation with stocks and bonds. Continued volatility may provide opportunities to rebalance portfolios. And we continue to keep an eye on asset classes that sell off dramatically and offer attractive forward-looking valuations. There’s no use in denying it. Volatility is back!