The Cornerstone Investment Commentary: 1st Quarter 2018
After going in one direction for the past few years (stocks up; interest rates down), 2018’s first quarter reminded us in no uncertain terms that both can move in the opposite direction as well. The new year’s first weeks gave no hint of this, however, as global stocks quickly rose 5% (foreign equities continuing to outpace US). This was wiped out by early February, and the decline reached the low double-digits before an unsteady recovery finished the quarter at an overall decline of ~1% for the broad global equity markets. Only emerging market stocks finished in the black. Rising interest rates caused US intermediate-term bond prices to fall 2%, with only very short-term bonds breaking even.
Looking closer, ‘growth’ stocks outperformed their ‘value’ counterparts as expectations remained that the overall economic expansions would stay robust. Interest-rate sensitive areas like utilities, energy and real estate suffered. Of unknown significance (yet) is that this reversed itself in March as value stocks held up better than growth. This definitely has our attention.
There is growing concern that corporate profit growth will slow after the one-time boost from the big US corporate tax cut. These concerns rise when 1) the pace of interest rate increases accelerates; 2) a tight labor market leads to rises in wage costs; 3) US trade policy (tariffs, retaliation, uncertainty, etc.) lessens demand for its products globally; and 4) higher consumer spending from job growth and individual tax cuts won’t be enough to offset these. These are credible concerns, and all were present this past quarter. Not surprisingly, volatility came roaring back, especially as US stock values are so high and the tax cut-fueled corporate profit boost is a one-time event.
Against this backdrop, your portfolio is in a somewhat defensive position. Overall equity holdings are about one-tenth lower than if stocks were more ‘fairly’ valued. Foreign holdings are at their highest level in years. By ~55/45, you hold more value than growth stocks. Your bond holdings are have an average maturity of two years of less, a very short-term leaning. Happily (so far!), all our changes in 2017-18 were helpful; your portfolio’s ‘expense ratio’ is less than 0.3% (the average exceeds 1.0%), and our tax-efficient approach means you have paid very little tax relative to your investment gains since 2009.
Most importantly, we believe your portfolio is properly positioned given the economic and political winds. If recent volatility is short-lived and the rest of 2018 looks like 2017, you will reap most – though not quite all – the available gains. However, if these winds become a storm due to some combination of the four causes above, your portfolio will fare better due to its current position. In addition, any monies we know you to need for the next 5-10 years are in short-term bonds that would be unaffected by a severe market decline. Please know that we always welcome your thoughts or questions on these matters.
As always, thank you for the continuing privilege of working with you. Happy Spring and approach of Summer until we are in touch again!