Leigh Lowman, Investment Manager
Risk assets finished the quarter in strong positive territory but experienced a pullback in March after notably strong performance for the first two months of the year. In a widely anticipated move, the Fed increased interest rates by 25 basis points on March 15 and rhetoric alluded to the possibility of an additional 2-3 rate hikes this year. However, headlines during the quarter were dominated by speculation surrounding the Trump administration economic plan. After initially surging in the post-election market, investor confidence began to wane as pro-growth policies have yet to come to fruition. Efforts to reform Obamacare were thwarted just prior to the Congress vote on March 24, but uncertainty still remains on the future of healthcare. Overall, economic data remains positive with low unemployment and positive earnings reports and we continue to see signs of improved global growth.
The S&P 500 Index was flat for the month but finished the quarter up 6.1%. Sector performance was mixed with the technology sector (+12.6%) posting double-digit returns for the quarter. Likewise, healthcare (+8.4%) posted strong quarter returns, a sharp reversal from the sector’s poor performance last year. Energy was negative for both the month (-1.0%) and the quarter (-6.7%). Financials lagged in March (-2.8%) but remained positive for the quarter (+2.5%). Growth outperformed value and large cap led both mid and small cap.
Developed international equity outperformed domestic equity for both the month and quarter, up 2.9% in March and 7.4% for the first quarter. Economic data leaned positive for the European Union and Japan as both regions experienced a pick-up in global earnings and nominal growth. Recent outcomes of European regional elections may also have signaled a weakening in the populist movement, but political uncertainty is still apparent as upcoming elections begin to unfold.
Emerging markets were up 2.6% for the month and 11.5% for the quarter. The region rebounded from a difficult fourth quarter as fears of US protectionism began to dissipate.
The Bloomberg Barclays US Aggregate Index was flat for the month and up 0.8% for the quarter. During the month, the 10 year Treasury yield rose as high as 2.6% in anticipation of the Fed raising interest rates, but finished the quarter at 2.4%, slightly lower than where it started in 2017. After steadily contracting during the first two months of the year, high yield spreads slightly widened in March but still remain at relatively low levels. Municipal bonds outperformed taxable bonds during the quarter, largely due to limited supply and solid demand.
We remain positive on risk assets over the intermediate-term, although we acknowledge we are in the later innings of the bull market and the second half of the business cycle. While our macro outlook is biased in favor of the positives and recession is not our base case, especially considering the potential of reflationary policies from the new administration, the risks must not be ignored.
We find a number of factors supportive of the economy and markets over the near term.
- Reflationary fiscal policies: With the new administration and an all-Republican government, we expect fiscal policy expansion in 2017, including tax cuts, repatriation of foreign sourced profits, increased infrastructure and defense spending, and a more benign regulatory environment.
- Global growth improving: U.S. economic growth is ticking higher and there are signs growth outside of the U.S., in both developed and emerging markets, is improving.
- Business confidence has increased: Measures like CEO Confidence and NFIB Small Business Optimism have spiked since the election. This typically leads to additional project spending and hiring, which should boost growth.
- Global monetary policy remains accommodative: The Federal Reserve is taking a careful approach to policy normalization. ECB and Bank of Japan balance sheets expanded in 2016 and central banks remain supportive of growth.
However, risks facing the economy and markets remain, including:
- Administration unknowns: While the upcoming administration’s policies are currently being viewed favorably, uncertainties remain. The market may be too optimistic that all of the pro-growth policies anticipated will come to fruition. We are unsure how Trump’s trade policies will develop, and there is the possibility for geopolitical missteps.
- Risk of policy mistake: The Federal Reserve has begun to slowly normalize monetary policy, but the future path of rates is still unclear. Should inflation move significantly higher, there is also the risk that the Fed falls behind the curve. The ECB and the Bank of Japan could also disappoint market participants, bringing the credibility of central banks into question.
The technical backdrop of the market is favorable, credit conditions are supportive, and we have started to see some acceleration in economic growth. So far Trump’s policies are being seen as pro-growth, and investor confidence has improved. We expect higher volatility to continue as we digest the onset of new policies under the Trump administration and the actions of central banks, but our view on risk assets remains positive over the intermediate term. Higher volatility can lead to attractive pockets of opportunity we can take advantage of as active managers.
Source: Brinker Capital. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. Indices are unmanaged and an investor cannot invest directly in an index. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting.
Barclays Municipal Bond Index: A market-weighted index, maintained by Barclays Capital, used to represent the broad market for investment grade, tax-exempt bonds with a maturity of over one year. Such index will have different level of volatility than the actual investment portfolio. S&P 500: An index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Companies included in the Index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor’s. World Index Ex-U.S. includes both developed and emerging markets. Bloomberg Barclays U.S. Aggregate: A market capitalization-weighted index, maintained by Bloomberg Barclays, and is often used to represent investment grade bonds being traded in the United States.
Brinker Capital Inc., a Registered Investment Advisor.