What a difference a year makes! After a slow, steady, rewarding climb in 2017, investment markets bounced up and down in nerve-wracking fashion for the first three months of 2018. In January, stock markets raced to new record highs at an unsustainable pace. The strong economy and low unemployment stoked fears of rising inflation and higher interest rates. As the 10-year US Treasury yield rose from 2.6% to nearly 3% in a 4 week period, the US stock market experienced a 10% correction for the first time in two years. Rising interest rates also caused bond values to fall, and February account statements showed the first significant monthly declines since before the 2016 elections.
Worries about inflation subsided in early March, but investment volatility continued due to headlines about rising geopolitical threats and tweets about trade wars. Higher tariffs and lower import quotas have a negative impact on economic growth and tend to kindle inflation. After all the sharp moves in stock prices and interest rates, many investors are surprised to learn the S&P 500 Index declined by less than 1%, the US Bond Aggregate Index dropped by about 1.5% and the MSCI-EAFE Foreign Stock Index fell less than 2% in the first quarter of 2018.
With Facebook under scrutiny for their (lack of) privacy policies and US bombs targeting Syria in response to suspected chemical weapons usage, investor jitters remain elevated. In response to these risks, investment markets have been resilient. Economic fundamentals continue to look strong. The US unemployment rate is low and the number of underemployed Americans has continued to drop. The same is true in most European countries. World economic growth projections by the IMF have been revised higher recently and no major global economy is currently in recession.
The current bull market in US large cap stocks turned nine years old in March (remember March 2009?). In January, many analysts were saying stock markets looked overvalued based on above average Price/Earnings ratios. But two things happened since then. Stock prices declined and corporate earnings increased. Now current P/E ratios are closer to their long-term averages. Corporate earnings for the fourth quarter of 2017 exceeded expectations and grew by about 15%. Earnings in 2018 should be bolstered by global economic growth and lower corporate tax rates. While this bull market is mature, strong earnings in 2018 would suggest further gains are possible.
The return of volatility in investment markets in 2018 is more likely the result of political dysfunction in the US and heightened tensions around the world than fundamental changes in the economy and corporate profitability. As investors, we should focus on our own financial objectives and maintain a diversified portfolio based on our personal risk tolerance. Changing market conditions are part of long-term investing, but we need to control our urge to overreact to those changes.
This article was authored by Christopher Borden, CRPS®, a financial advisor located at Canby Financial Advisors, 161 Worcester Road, Suite #408, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.
© 2018 Canby Financial Advisors