The risk-on theme persisted through the first quarter as improving economic data trumped elevated geopolitical uncertainty, both in the U.S. and abroad. Economies in the U.S. and Europe continued to gain traction and the U.S. entered its 93rd month of expansion.
In a widely expected move, the Fed raised rates in March by 25 bps, bringing the fed funds rate to 0.75% – 1.0%. The Federal Reserve Board expects two more rate hikes this year. Markets were unfazed and both stocks and bonds rallied.
The S&P 500 Index surged 6.1%—its best quarterly performance since the fourth quarter of 2015—as expectations for lower taxes, reduced regulation, and other pro-growth reforms helped propel U.S. equity prices to new highs. The equity market’s subdued volatility in the first quarter was also noteworthy. The S&P 500 Index had more than 100 days without a 1% decline prior to March 21, when the Index sank 1.2%—the longest stretch since 1995—and only two days during the quarter saw such moves.
The VIX, which measures the implied volatility of S&P 500 Index options, closed the quarter at 12, well below its long-term average (since 2004) of roughly 20. At the same time, valuations are lofty (as measured by several oft-cited metrics), potentially painting a scenario for rocky times ahead.
Non-U.S. stocks also posted strong returns, and emerging market equities beat developed markets. U.S. Treasury yields were range-bound leading to fairly flat returns, and the riskier sectors in fixed income posted the best results. Commodities were the lone area to deliver a negative return, hurt mostly by oil prices falling due to concerns over stockpiles in the U.S.
Economic data in the U.S. were generally strong in the first quarter. Unemployment fell to 4.7% and private nonfarm payroll growth was robust. Consumer confidence, as measured by the Conference Board, hit its highest level since December 2000. Housing data also continued to show strength; U.S. single family home starts approached a 10-year high. The Composite Housing Market Index (National Association of Home Builders-Wells Fargo) jumped 9.2% during March, representing the largest gain since June 2005. Inflation edged up with February’s headline CPI figure at 2.8% (year-over-year), the fastest rate in five years, and core CPI (excluding food and energy) at 2.2%. The Fed’s favored measure, the Personal Consumption Expenditures Price Index, grew 2.1% year-over-year, the most since April 2012. Wage growth also picked up; average hourly earnings grew 2.8% (year-over-year) as of February.
Valuations are stretched by many measures across asset classes and markets have experienced extraordinarily low volatility, relative to historical norms. However, many risks lurk and there is no certainty that the pro-growth policies envisioned by enthusiastic market participants will come to fruition.
Given the sanguine view reflected in market prices, we encourage investors to temper expectations for returns and brace for more volatility, which we expect to increase from current levels. Much uncertainty remains with respect to the scope, implementation, and timing of Trump’s agenda, and myriad other geopolitical issues are confronting the world, as well. As always, Callan encourages investors to maintain a long-term perspective and prudent asset allocation with appropriate levels of diversification.
