After an abnormally serene market environment in 2017, volatility returned in the first quarter of 2018. Markets experienced a 10 percent equity correction off the late January highs, yet finished the quarter down a modest 0.6 percent (Russell 3000). Volatility was sparked by fears of increased inflation and potential trade wars. International equities declined slightly more over the quarter with a 1.4 percent loss (MSCI EAFE). Interest rates moved significantly higher creating a headwind for bonds. The 10-year Treasury yield increased 34 basis points over the quarter, ending the quarter at 2.74 percent. The broad U.S. fixed income market posted a 1.5 percent loss for the quarter (Barclays Aggregate).
U.S. economic data remained benign with the unemployment rate holding steady throughout the quarter at cycle lows of 4.1 percent. Fourth quarter U.S. GDP grew at a 2.9 percent pace, though this was a deceleration from the 3.2 percent growth achieved in the third quarter. Solid economic activity and tightening labor markets led the Federal Reserve to raise the fed funds rate again in March. The Fed also signaled the possibility of two or three more rate hikes in 2018. In spite of this solid economic backdrop, a higher-than-expected January wage growth report caused concern of elevated inflation and triggered higher interest rates and a sell-off in the markets. Additionally, tariffs on steel and aluminum announced by President Trump invoked concern of a potential trade war and added to volatility during the quarter.
Volatility is normal in the equity markets. Investors were spoiled with relative calm in 2017 with only a 3 percent pullback in the markets during the year. However, 2017 was an anomaly. In fact, historically markets have seen a 10 percent correction about once every year on average. As the chart of the quarter shows, the average intra-year S&P 500 decline has been 13.8 percent since 1980, yet in 29 out of 38 years it ended the year positive. With this in mind, it is important to maintain a long-term perspective and a well-diversified portfolio when investing in the markets.
