Uncompromising Commitment

Quarterly Capital Market Overview

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2017 CAPITAL MARKETS REVIEW
March 2017
James W. Underwood, CFA – Chief Portfolio Strategist

NO FEAR

The post-election stock market rally, which was launched by a renewed wave of growth optimism in late 2016, accelerated during the first quarter of 2017 as consumer confidence soared.  The Consumer Confidence Index, published by the Conference Board, reached 125.6 in March, reflecting its highest value since December 2000.  In the survey, consumers expressed improved outlooks related to business conditions, the labor market, and personal income prospects.  Additionally, the National Federation of Independent Business announced that its index of small-business optimism reached its highest level in over a decade during the first quarter.

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Coinciding with improving consumer sentiment, the CBOE Volatility Index, commonly referred to as Wall Street’s “fear gauge,” posted its second-lowest quarterly average on record, behind only the fourth quarter of 2006.

Greatly contributing to the reduced “fear” in the markets was the lack of material downside moves.  Between October 12, 2016, and March 20, 2017, the S&P 500 experienced 109 consecutive trading days without a 1% daily decline, marking the longest streak since May 1995. 

There were a few signs the economy is improving. The Commerce Department revised fourth quarter growth estimates higher, while the Personal Consumption Expenditures Price Index, the Federal Reserve’s preferred inflation gauge, exceeded the 2% annual target for the first time in nearly five years.  However, this economy desperately needs growth rates to accelerate.  According to the Commerce Department, 2016 marked the eleventh consecutive year of sub +3% real growth for the U.S. economy.  While rising consumer confidence may temporarily buoy growth, much of the longer-term focus remains on the ability of Washington to pass structural economic reforms. 

EQUITY MARKET REVIEW

Against this optimistic backdrop, the S&P 500 Index climbed 6.1% during the first quarter, marking the sixth consecutive quarter of positive performance.  The broad market index has now posted gains in sixteen of the last seventeen calendar quarters, a batting average only equaled three times since 1926 (Q2-1998, Q1-1999, Q2-1999).   As consumer confidence climbed, investors shifted into technology companies, believing the cash rich sector is best positioned to take advantage of an improving economy.  For the quarter, the Technology sector gained 12.6%, led by Apple Inc., which soared 24.5%, accounting for over 12% of the S&P 500’s quarterly gain.  On the opposite end of the sector spectrum, despite OPEC’s production cut agreement, excess supply concerns weighed heavily on oil prices, pulling the Energy sector down 6.7%.

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3_chartDuring the quarter, large cap companies outpaced smaller cap companies by a wide margin.  From a style perspective, after lagging significantly during 2016, growth stocks returned to favor, outpacing their value counterparts across the capitalization spectrum. 

The rally in confidence was not limited to the U.S.  Across the Eurozone, economic optimism reached five-year highs following early signs of broad-based earnings growth.  Also, recent data from Japan showed modest improvement; however, the strength of the Japanese yen has created an economic growth headwind.  With the rising sentiment, developed market currencies rallied versus the U.S. dollar, creating a very favorable environment for U.S. dollar-based investors.  For the quarter, the MSCI EAFE Index gained 7.4% with positive contributions from nearly every developed market around the world.

FIXED INCOME REVIEW

Investment markets generally move when actual outcomes differ from the expectations that are priced in to current levels.  While the fourth quarter of 2016 was extremely challenging for fixed income investors as interest rate expectations were reset higher, the Fed’s repeated message of moving gradually and modestly was clearly heard.  Consequently, despite the Fed’s decision to raise the range for the federal funds rate during the first quarter, longer-term yields remained stable as the Federal Reserve progressed along the expected path established in late 2016. 

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The combination of a stable yield curve and tightening credit spreads resulted in a generally favorable backdrop for fixed income markets with the Barclays U.S. Aggregate Bond Index climbing 0.8% during the first quarter.  Outside of the taxable bond market, tax-exempt bonds similarly benefited from the stable/predictable interest rate path and further benefited from attractive relative valuations following the significant selling pressure which occurred during the final quarter of 2016.

SATELLITE STRATEGIES

5_lastchartSource: Morningstar Direct, Welch Hornsby, Inc. – Emerging Mkt Equity: MSCI EM Index ($); Global High Yield: Barclays Global High Yield TR ($); US REITs – DJ US Select RESI TR ($); Emerging Market Debt – JPM EMBI Global Diversified TR ($); Commodities – Bloomberg Commodity TR ($); Int’l Small Cap: S&P Developed Ex US Small TR ($); Gold – S&P GSCI Gold ($)

The excitement about improving global growth prospects sent emerging markets sharply higher.  Both debt and equity markets were rewarded, climbing 3.9% and 11.5%, respectively.  In this “risk on” environment, Gold was an unlikely winner, driven by significant demand from China and India.  On the negative side, falling oil prices weighed heavily on the broad Commodities market, resulting in a 2.3% quarterly decline as measured by the Bloomberg Commodity Index.

 

 

 

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