A Tale of Two Markets

May 11, 2018  | by Ryan Driscoll

Market Commentary

Summary

  • Volatility returned in force in the first quarter of 2018 and both stock and bonds posted negative returns, making for a challenging quarter for investors

  • Investors are watching for signs of inflation as unemployment hits new cycle lows

  • Economic indicators and corporate earnings remain strong, supported by a still accommodative environment and tax cuts


The resurgence in market volatility in the first quarter of 2018 had many investors turning the calendar on March 31st with trepidation.  Returns in the fixed income and equity markets for the first three months of the year were modestly lower but the “roller coaster ride” that led to those returns strained investors.  It is a fairly infrequent occurrence to have both bonds and stocks produce negative returns for a full quarter. It is also not often, especially over the last two years, that investors must endure a gain or loss of one percent on almost 30 percent of the trading days in a quarter. However, it appears as though the extreme volatility has subsided (for the time being) and the current market environment of positive domestic economic data remains steady.

The initial report of real GDP for 1Q showed an increase of 2.3 percent after climbing 2.9 percent in the prior quarter. A separate Labor Department report showed that employment costs rose more than expected in the first quarter and private wages had the biggest annual gain since 2008. Consumer spending, the biggest component of the economy, increased 1.1 percent, matching estimates and marking the smallest gain since 2013.

Corporate earnings have far exceeded expectations in the first reporting period since the passage of the Tax Cuts and Jobs Act. Almost 450 of the reporting companies in the S&P 500 index have released 1st quarter 2018 earnings. Of those, 81 have surprised to the upside on an earnings-per-share basis with approximately 86 percent reporting positive growth. The overall average earnings growth rate was 23.5 percent with energy, information technology and financials the top performing sectors.

The employment picture continues to steadily improve. The jobless rate fell to 3.9 percent from 4.1 percent a month earlier. Employers added a total of 164,000 jobs and have created an average 200,000 jobs a month this year, up from last year’s average gain of 182,000. The most recent employment report also showed average hourly pay has grown by 2.6 percent over the past year. The labor force contracted month over month but has grown by 1.3 million from a year earlier. Market participants continue to watch for signs of wage pressures that could drive inflation as unemployment has now reached its lowest level since 2000.

img_two_markets_CH1_NonFarmPayrollEmployment

To that point, inflation has moved above “trend” as of late. The employment cost index, a part of the GDP report which includes wages and benefits, rose 0.8 percent from the previous quarter. Despite a softer-than-expected monthly increase, April headline CPI edged up to 2.5 percent while core CPI held steady at 2.1 percent. Meanwhile, a key inflation gauge watched by the Federal Reserve, core PCE, rose at the fastest pace in more than a year. Both headline and core PCE inflation matched consensus expectations. Over the last 12 months, core PCE accelerated to 1.9 percent. The uptick largely reflected base effects as a monthly decline last March fell out of the equation. Still, the measure is now on track to hit the Fed’s 2 percent target supporting continued rate hikes going forward.

Heading towards fiscal year-end, like Charles Dickens, we might conclude “that it was the best of times and the worst of times.” The first half of the fiscal year 2018 treated investors to excess returns in a surprisingly low volatility environment while the second half, so far, has made any incremental portfolio gains a test of will. However, as investors reassess the risk profile of the overall portfolio, it is important to recognize that the accommodative policies put in place during the crisis, along with the Tax Cuts and Jobs Act have laid a foundation for stronger domestic economic growth that will likely play out for the remainder of 2018.  As a result, we believe that there are still good, if not best of, times remaining for 2018.

Authors

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Ryan Driscoll is responsible for trading, investment analysis. He is a member of the Treasury Solutions team since its inception. Ryan is an active participant in the investment and rebalancing process, manages the quarterly reporting process and is actively engaged with Treasury clients. Prior to joining Commonfund, Ryan worked at Sailfish Capital Partners, a multi-strategy fixed income fund, where he served on the Emerging Markets team. Prior to that, he was on the fixed income team at Grantham, Mayo, Van Otterloo & Co. and was an equity/fixed income trader at Loring, Wolcott and Coolidge, in Boston. Ryan received his B.S. in Finance and M.S. in Global Financial Analysis (with Distinction) from Bentley College. He is a CFA Charterholder and is a member of the Boston Securities Analyst Society and CFA Institute.
Ryan Driscoll
Director, CFA

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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.