Last year, the markets made a steady climb and volatility was at historic lows. Yet, so far in 2018, markets have reversed course as market momentum, and the euphoria from the tax reform package gave way to fears that the Federal Reserve might raise rates too aggressively.
After posting an impressive January, the markets for the first quarter of 2018 suffered a wave of ups and downs resulting in the first 10% correction in the S&P 500 since 2016. President Trump’s proposed steel tariff and its potential of touching off a full-scale trade war with the Chinese exacerbated this rate-induced volatility. Once the rhetoric around the tariffs softened, the market attempted rallies several times, but they were not enough for U.S. markets to finish the quarter in positive territory.
For the three months ending March 31, 2018, the S&P 500 was down 0.76%, breaking a string of nine consecutive quarters of gain, while U.S. small cap stocks (Russell 2000) slipped by only 0.08%. Abroad, the developed countries (MSCI EAFE) fell by 1.53%, but developing markets (MSCI EM) were up 1.43%. REITs struggled in response to interest rate pressures ending the quarter down 7.43%. Bonds, usually a safe haven when equities falter, were more influenced by interest rate trends, and the BarCap Aggregate finished the quarter down 1.46%
“The stock market is a wonderfully efficient mechanism for transferring wealth from the impatient to the patient.”
– Warren Buffett
In 2017, the markets experienced one of the lowest levels of volatility in years, with the VIX, often referred to as the fear index, hitting an all-time low in November. However, by the end of the first quarter 2018, the VIX had shot up by 81%, the highest it had been since 2011. We remarked in our last commentary that the S&P had only four days last year where it traded above or below 1%. So far in 2018, it has already been up over 1% twelve times and down at least 1% eleven times! What a difference a year makes!
This latest bout of volatility reminds us that market conditions like last year are the exception that proves the rule. Unfortunately, some investors had grown too comfortable with the recent bull market cycle, and expected more of the same – a phenomenon in behavior psychology known as “recency bias”. As such, the negative return in the first quarter seemed unusual in the context of the nine previous positive quarters, causing some investors to overreact. While market volatility can be nerve racking for investors, reacting emotionally and changing long-term investment strategies in response to short-term declines can prove more harmful than helpful.
At Wealth Dimensions, we tailor our prudently diversified portfolios to each client’s goals, time horizon and risk tolerance. We employ a disciplined approach in rebalancing portfolios as we see opportunities. We do not react to short-term gyrations by trying to time them or take defensive postures. We do, however, have plans in place to capture value created when volatility presents itself as a way of enhancing our long-term results.
As we move forward in 2018, we can expect a continued tug-of-war between market forces pushing higher in response to general economic conditions and a Fed who is looking for opportunities to normalize rates, which could cause further volatility. Most economists see our present economic picture as balanced with healthy corporate profits, low unemployment, tame inflation and relatively low interest rates. Despite all the noise from geopolitical events, political rancor and recent market jitters, economic conditions remain favorable for company profits.
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