Volatility. It’s back.
After a prolonged period of relative calm in the global markets, volatility has reared its head again since the beginning of February.
Consider that during the first quarter, the S&P 500 Index moved up or down 1% or greater in 23 trading days or about 38% of the time, while only 2 days did it show such movement in the first quarter of 2017. US equity markets also experienced the first correction (decline of 10% or more) in nearly two years.
For the first quarter, the S&P 500 Index declined -0.76%, while the Dow Jones Industrial Average declined by -1.96% and the Nasdaq Composite Index advanced +2.59%. International markets also experienced declines, with the Bloomberg World Index down -0.43%. Fixed Income was unable to provide a safe haven, as the Barclays US Aggregate Bond Index was down -1.46% for the quarter.
Relative to their respective benchmarks, the strategies that we manage at Biondo fared relatively well. After fees, the Biondo Focus Strategy was up 4.67%, the Biondo Growth Strategy was up 3.90% and the Biondo Dividend Strategy declined 5.25% during the quarter. Allocations to other strategies including International and Fixed Income yielded mixed results.
Bigger picture, we see a tug of war going on in the markets. On the positive side – earnings growth is very strong and companies are very healthy on the balance sheet. In 2017, S&P 500 earnings grew 12% and consensus estimates are for 19% and 10% for 2018 and 2019 respectively. Economic reports remain strong in terms of unemployment – which in February sat at 4.1% and its lowest level since December of 2000. GDP growth continues to be positive and expectations are strong for 2018.
On the negative side – valuations are elevated, the Federal Reserve is becoming less accommodative at a more aggressive pace than market participants anticipated earlier this year, the threat of inflation looms with healthy employment data and recent talk of a trade war with China having unnerved investors.
In late January, the S&P 500 Index was trading at north of 19x forward earnings at the peak and post-correction closed the quarter at 17x expected 2018 earnings. While this does not approach the worst valuation conditions we have seen in our years, equities are simply not cheap. Earnings growth can absorb a lot of downside pressure but companies will need to deliver.
Despite a bevy of geopolitical concerns, the Federal Reserve remained on pace to normalize policy. The Fed lifted the target range for interest rates to 1.50%-1.75%, citing stable economic fundamentals. The Fed also forecast higher growth and inflation targets but stated the concerns as near-term given the transitory impact expected from tax cuts and fiscal spending policy.
As we stated in our last Perspectives, inflation remains our primary concern as we are approaching the later stages of this economic cycle. Inflation concerns ignited volatility early in February, but more recent economic reports have alleviated many fears. Recent data suggest more measured wage growth and potentially more slack in the labor markets due to job additions. While near-term inflation concerns appear to have subsided, we will continue to monitor this data closely and inflation remains our top concern as we look forward.
Just as February’s bout of heightened volatility appeared to be subsiding, talk of a trade war gripped the markets after the Trump Administration proposed levies on certain Chinese imports, most notably steel and aluminum. Chinese leadership fired back, proposing increased tariffs on U.S. exports to China, sparking fears among investors. Historically, trade tariffs have been inflationary and that has traditionally put downward pressure on valuations and asset prices, especially the U.S. dollar. At the end of the day, we view the threat of a trade war with China as a low-probability event, as neither country wins and both lose. But political theater often plays out in public, while the real negotiations will be private.
As this battle between the positives and the negatives play out in the next several months, we expect volatility to remain elevated yet not quite as severe as in recent weeks. From a portfolio management perspective, tactical decisions will be required to successfully navigate this environment. This means managing position sizing – trimming holdings that have grown too large or have become too expensive and adding to others that we believe to be undervalued. In that sense, volatility can be good if we use it to our advantage. It also means that it is imperative for clients to communicate any needs for liquidity with as much advance notice as possible.
As we look to the balance of 2018, we believe that our strategies are well positioned for the risk-reward opportunities that we see. While uncertainty is a constant, we remain focused on owning great companies run by bright people with attractive growth opportunities or the ability to return cash to shareholders. We continue to believe that International markets offer attractive growth prospects and are encouraged by an improving Fixed Income market.
Please feel free to reach out to us to review your personal situation so that we can ensure that we have built your portfolio to accommodate your various needs and address any concerns that you may have. We appreciate the opportunity to serve you and appreciate the trust and confidence that you have placed in our firm.
Joseph P. Biondo
Chief Executive Officer
Chief Investment Officer
Sources: Volatility – Bloomberg & NBC News, Indices – Bloomberg, Strategies – IAS, Earnings – FACTSET, Bloomberg & Forbes, Unemployment – U.S. Dept of Labor & CNN Money.
The information set forth regarding investments was obtained from sources that we believe reliable but we do not guarantee its accuracy or completeness. Neither the information nor opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Past performance does not guarantee future results.