In January, enthusiasm for economic growth and pending US tax cuts lifted the S&P 500 5.7%. February brought talk of trade wars, higher interest rates, and the return of volatility as major stock indexes declined 10% from highs before ending the month with a 3.7% loss on the S&P 500. March started with steady gains before the “tech wreck” took hold, pushing down the major US stock index by 2.5% for the month as investors reassessed a sector that has generally been considered the growth engine of the global economy. For the year through March, the S&P 500 index shows a small loss of 0.76%, including dividends.
In contrast to February, modest returns on bonds in March dampened the impact of the stock market declines. Despite a hike in short-term rates and a somewhat hawkish tone from the new Federal Reserve Chair, longer-term interest rates fell. After a hyper-focus on inflation just a few months earlier, bond investors are now looking for safety as they exit riskier bonds and flock to Treasuries amid a more volatile stock market.
What’s the Story?
In the short term, markets tend to ride on the narrative of the moment. After the election, the markets focused on the idea that the Trump administration would release capitalism’s animal spirits with looser regulations and lower taxes on businesses. This coincided with the Goldilocks (not too hot and not too cold) narrative positing that a synchronized global economy was doing well but not so well as to reignite inflation and cause central banks to push up interest rates too fast. This narrative lasted most of 2017 and drove stocks to a very profitable and surprisingly tranquil year.
As stocks pulled back, the narrative shifted. The benefit of tax cuts has been replaced with worries of an escalating trade war. The threat of regulations on big tech companies intensified after the Facebook/Cambridge Analytica scandal. Add in the President’s twitter attack on Amazon, the largest contributor to the S&P 500’s YTD return and the negativity builds.
Sometimes the narrative can turn the economy – clearly the terrorist concerns following 9/11 negatively impacted consumer spending. More often, these market narratives simply become short-term noise. While it would be unfeasible to craft a successful strategy based on constantly changing stories, understanding these narratives offers insight into what is driving markets in the short-term. What can be understood can be more easily withstood.
What We Are Doing
We are cautious at this juncture, as valuations on equities are still high and the stock market’s nine-year run is not likely to be sustained without a more meaningful correction in prices. If history is a guide, returns are often lower when market turbulence is elevated. We don’t think that means investors should drastically change course as the payoff from doing so is meager and the opportunity cost can be high.
For clients and accounts with new funds to invest, we are using multiple tranches to enter stock investments and prudently manage risk. For existing portfolios, we continue to fine-tune towards high-quality stocks and rebalance around strategic allocations. On the bond side, we continue to keep a lid on the credit exposure and reduce exposure to international markets as central banks debate tightening monetary policy.
What It All Means
As we write, the second quarter has started on a down note, retesting correction territory. Trade tensions continue to escalate with China, but tariffs alone are unlikely to throw the economy into a recession. For now, tariffs and a limited trade war will only marginally impact consumer prices and corporate profits. Some companies will feel more pain than others, but exactly who is affected will continue to be cloudy. Avoiding concentrated positions is increasingly important as this trade war unfolds.
Financial markets dislike uncertainty. Untested leadership at the Federal Reserve has many investors on edge. It’s increasingly evident that uncertainty is a defining feature of the Trump Administration. All this is unnerving to investors as the administration quixotically tackles one geopolitical issue at a time. For the time being, we don’t expect a return to a calm market environment. Please let us know if you would like to discuss your situation in detail.
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DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Proffitt & Goodson, Inc. makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. The information is subject to change and, although based on information that Proffitt & Goodson, Inc. considers reliable, it is not guaranteed as to accuracy or completeness. Source information is obtained from independent financial data suppliers (Interactive Data Corporation, Morningstar, etc.). The Market Categories illustrated in this Financial Market Summary are indexes of specific equity, fixed income or other categories. An index is a reflection of the underlying securities in a particular selection of securities picked due to a particular type of investment. These indexes account for the reinvestment of dividends and other income, but do not account for any transaction, custody, tax, or management fees encountered in real life. To that extent, these index numbers are artificial and cannot be duplicated in real life due to the necessity of paying those transaction, custody, tax, and management fees. Industry and specific sector returns (technology, utilities, etc.) do not account for the reinvestment of dividends or other income. Future events will cause these historical rates of return to be different in the future with the potential for loss as well as profit. Specific indexes may change their definition of particular security types included over time. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of Proffitt & Goodson, Inc. Past performance does not guarantee future results.