MARKET UPDATE | First Quarter 2018

Adam Recker, CFA, CFP® & Michael Furla, CFA

The incredible run of positive stock market returns throughout 2017 and January 2018 finally came to an end in February, when the market dropped 10%—resulting in an uptick of investor concern and volatility.

MARKET SPOTLIGHT: INCREASED VOLATILITY & PROPOSED TARIFFS

The incredible run of positive stock market returns throughout 2017 and January 2018 finally came to an end in February, when the market dropped 10%—resulting in an uptick of investor concern and volatility. As illustrated below, the volatility increase was material compared to the lows investors became accustomed to, but wasn’t excessive compared to historical levels. It still remains to be seen if we’ve moved from the lower volatility regime that we were in, to an environment where volatility remains at a higher level, but there are a few factors to consider. First, tax cuts and increased governmental spending are near-term benefits that could give the stock market and economy more room to run, however, since we’re likely long into the business cycle, these measures also increase the risk of the economy overheating. Fortunately, inflation readings have yet to hit problematic levels and the tax overhaul should benefit corporations, enabling them to increase investment, dividend payouts and share buybacks.

Another factor to consider are geopolitical risks, namely an increase in US protectionism. Higher tariffs could lead to a slowdown in global trade, which would hurt all parties and could have other unintended consequences. The chart on the next page shows how the proposed tariffs could affect the US versus China, illustrating a lesser impact to the US given we import more from China than China imports from the US. China could retaliate through other channels, however, such as no longer purchasing large quantities of US treasuries, which would make our debt and fiscal situation more precarious.

Regardless of these fears, we don’t have reason to believe either side truly wants a trade war or has the desire to institute the proposed tariffs. The proposed actions could in fact simply be a tactic to gain position as part of a larger negotiation strategy.

Another factor affecting market volatility is rising bond yields in the US. Following the Great Recession, artificially low interest rates forced investors into stocks where higher dividend-paying companies served as bond-proxies. Now that yields are starting to rise, at least for shorter maturities, they’re starting to give dividend-paying stocks some competition for investors’ capital. If these higher yields lead to outflows from stocks and into bonds, along with higher interest rates making companies’ cost of borrowing more expensive, volatility in asset prices could result.


KEY TAKEAWAYS FOR INVESTORS
  • Volatility isn’t excessive relative to history, but is materially higher.
  • Risks on the horizon include continued geopolitical tension, including potential trade retaliation and tariff implementation.
  • Higher yields may start to attract more money into bonds versus stocks.

View Full Market Update


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