Q1 2018 Getting Back to Normal?
COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q1 2018 - Getting Back to Normal?
Q1 2018 - Getting Back to Normal?
One could argue that the first quarter of 2018 was a tale of two markets. It was all systems go in January with markets rallying into the new year, finishing the month well in the mid-single digit range. February proved to be the complete opposite as markets fell on a "good news" scenario. Employment data released for January pointed to a higher than expected wage increase number sparking fears of higher interest rates and inflation. Volatility that had been absent for months instantaneously rattled the investing landscape causing several large intra-day moves in the major indices in the days following. An attempted recovery in early March faded as new concerns surfaced regarding tariffs and whether or not that would lead to an all-out global trade war. The week of March 19th saw equity markets plunge 5% as investors pondered their next move. The final days of March were strong enough to erase most of the earlier decline. The S&P 500 finished in negative territory for the quarter with a total return of -0.76% and broke a 9-quarter win streak. The tech-heavy NASDAQ finished the quarter +2.59% as the strong gains in January were enough to keep the sector afloat during the correction. The FANG names (Facebook, Amazon, Netflix, Google) continue to drive performance in the growth indices driving their weights higher in popular passive ETF vehicles. The Federal Reserve raised rates in March as expected taking the Fed Funds range to 1.50-1.75%. Markets have priced in two more rate hikes but investors are preparing themselves for a possible fourth hike. Earnings season begins in mid-April and expectations are the highest they have been in years. Consensus estimates are for 15-20% earnings growth year over year largely due to the impact of tax reform.
Foreign markets were not immune from the global correction in the quarter. The MSCI EAFE Index was down -1.70% but Emerging Markets fared better returning +1.30% which seems counterintuitive in a risk-off environment. The ECB continues to be accommodative with its monetary policy but has signaled the possibility of pulling back some of the quantitative measures that have been in place for years. Economic indicators are consistent with 2.00% GDP growth for 2018. Labor markets are healing which should support domestic demand and capital spending continues to surprise on the upside.
The normally calm fixed income market brought plenty of excitement to the table (moved in a 60-basis point range at the 10-year treasury). Markets have become used to low interest rates and any sudden spike in yields is sure to make investors adjust their outlook for risk assets. The 10-year treasury finished the quarter at 2.74% and came extremely close to the 3.00% threshold at one point in time. Equity markets are pricing in the reality of higher rates and we expect the journey to be choppy. History says markets can absorb higher interest rates if the trend is steady and we believe that will be the case. The Fed should aid us in this endeavor as they have done a remarkable job of telegraphing their future actions thus far. As shorter yields have increased the shape of the yield curve has begun to flatten. Historically this has signaled a possible recession on the horizon and an end to the current cycle but the Investment Committee feels there is room to go before we reach a state of inversion. On the positive side, investors are finally able to earn decent yield for short term cash and have an incentive to exit out of low yielding money markets and bank deposits. Even though rates have moved up, they remain well below long-term benchmarks and significantly short of their all-time highs.
Foreign markets were not immune from the global correction in the quarter. The MSCI EAFE Index was down -1.70% but Emerging Markets fared better returning +1.30% which seems counterintuitive in a risk-off environment. The ECB continues to be accommodative with its monetary policy but has signaled the possibility of pulling back some of the quantitative measures that have been in place for years. Economic indicators are consistent with 2.00% GDP growth for 2018. Labor markets are healing which should support domestic demand and capital spending continues to surprise on the upside.
The normally calm fixed income market brought plenty of excitement to the table (moved in a 60-basis point range at the 10-year treasury). Markets have become used to low interest rates and any sudden spike in yields is sure to make investors adjust their outlook for risk assets. The 10-year treasury finished the quarter at 2.74% and came extremely close to the 3.00% threshold at one point in time. Equity markets are pricing in the reality of higher rates and we expect the journey to be choppy. History says markets can absorb higher interest rates if the trend is steady and we believe that will be the case. The Fed should aid us in this endeavor as they have done a remarkable job of telegraphing their future actions thus far. As shorter yields have increased the shape of the yield curve has begun to flatten. Historically this has signaled a possible recession on the horizon and an end to the current cycle but the Investment Committee feels there is room to go before we reach a state of inversion. On the positive side, investors are finally able to earn decent yield for short term cash and have an incentive to exit out of low yielding money markets and bank deposits. Even though rates have moved up, they remain well below long-term benchmarks and significantly short of their all-time highs.
THOUGHTS ON ASSET ALLOCATION
In 2017 investors could pretty much sleep walk through the year and be happy with returns on their portfolio. We feel 2018 will require more attention and patience as we navigate through uncertainty on the inflation and interest rate front. We are comfortable with our focus on value over growth given stretched valuations and narrow breadth in the growth space. If the correction stays in place for a while longer we feel we have the active manager set that will hold up better relative to their respective benchmarks. The market correction has provided us with a gift of more reasonable market valuations. At 16x forward earnings for the S&P 500, the index is more in line with the 30-year median. Valuations at these levels coupled with a strong earnings season ahead should lend support to the equity markets making any reasonable sell-off a buying opportunity for long-term investors. In fixed income we remain dedicated to our short-term bias to avoid volatility associated with the longer end of the yield curve. In our view interest rates should edge higher as long as the economy continues to cooperate as predicted.
The first quarter was filled with mixed results among various major asset classes. As active managers we look for investment talent that can weather tough market environments and protect capital in times of distress. Listed below is a subset of our equity manager universe that performed very well in a quarter that was filled with investor angst and uncertainty.
Investment Manager / *Q1 2018 Return / Manager Benchmark
T. Rowe Price Inst. LC Growth Fund / +4.19% / +1.42% Russell 1000 Growth
Oakmark Fund / -1.11% / -2.83% Russell 1000 Value
Cambiar International Equity / -0.96% / -1.70% MSCI EAFE NR
T. Rowe Price Mid Cap Growth / +3.60% / +2.17% Russell MC Growth
MFS International Discovery Fund / +1.82% / +0.49% MSCI World Ex-USA
*Returns are expressed as composite returns. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Gerardo Rodriguez, Investment Officer, at 786-292-0310.