A Strong First Quarter Ends on an Uncertain Note
Stocks were due for a pause after the powerful surge following the election in November. But beyond simply needing time to digest those gains, the rally stalled as investors took stock of the political landscape and began to temper their enthusiasm for sweeping policy change. Importantly, however, stocks did not give back very much of their post-election gains as the quarter came to a close. In fact, the S&P 500 ended the quarter just 1.5 percent below its March 1 record high of 2396.
As the new quarter gets underway, in addition to policy, investor concerns are lately centered on questions concerning the relative strength of the economy, and the usual jitters about the upcoming first quarter earnings season. A lot of handwringing has followed evidence that while so-called soft economic data has been strong recently, that same strength has not shown up in the so-called hard data. In our view, such concerns are overdone. But if the potential boost from policy turns out to be smaller and possibly delivered later than hoped, and the underlying economy is softer than forecast, the pressure on earnings to deliver has increased, especially with equity valuations on the high side. Factset estimates earnings will grow 9.1 percent in the first quarter, after a smaller-than-usual estimate decline from the start of the year[i].
Just as stocks in the U.S. were beginning to stall in March, stocks in the Eurozone began to surge. The EuroStoxx 50 index rallied by 5.5 percent in March after a modest gain in February and a small decline in January, closing out the period 6.4 percent higher, and higher by 7.9 percent in dollar terms. It was the opposite monthly pattern exhibited by U.S. stocks throughout the quarter. As political uncertainty increased at home, it began to recede somewhat in the Eurozone following relatively poor showings by populist candidates in Dutch national elections and in German regional elections. Economic optimism also rose, just as it began to fade at home. And just as the Federal Reserve was raising interest rates in March for the second time in three months, the European Central bank was reiterating its commitment to accommodation.
Stocks in Japan fell 1.1 percent in the quarter after failing to gain any traction throughout. Dollar weakness played a big role, as it began the year at 117 yen and closed it at 111. As a result, in dollar terms the Nikkei index actually gained 3.7 percent.
The star performers for dollar-based investors in the quarter were the emerging markets. The MSCI Emerging Markets index delivered a solid 7.5 percent gain in local currencies, which translated into an 11.1 percent gain in dollars, as worries over dollar strength and possible trade wars dissipated, with particular strength in Asia.
Positive returns on bonds
It may come as something of a surprise, but bonds also delivered positive returns in the quarter. Although, like stocks, bond yields peaked in March, they have been trading in a fairly tight range since mid-December. Since then, the yield on the ten-year note has ranged between 2.30-2.60 percent. For the quarter, the Bloomberg Barclays Aggregate Bond index rose 0.8 percent, a sharp turnaround from the fourth quarter when the yield on the ten-year note rose from 1.59 to 2.44 percent. Lower quality bonds outperformed in both the investment and below-investment grade space, but like stocks, faded in March as credit spreads widened. The Bloomberg Barclays un-hedged Global Aggregate index rose 1.8 percent in the quarter.
A look ahead
As the second quarter gets underway, Congress must immediately focus on legislation to fund the federal government beyond the April 28 expiration of the current continuing resolution. These negotiations are expected to be difficult, as well as divert attention from tax reform and other policy priorities of the administration. The Federal Reserve meets twice in the second quarter, in May and June. According to Bloomberg, expectations for another rate hike in May are just 13 percent. But in June, the next meeting also accompanied by a press conference, the odds are 57 percent. By the next such meeting in September, the odds are 80 percent. [ii] Overseas, the French elections are fast approaching. The first round will take place on April 23, with the final on May 7. And now that Article 50 has been invoked, Brexit negotiations will get underway. And while they will stretch over as much as a two-year period, the details of both the terms of exit and the ongoing relationship with the EU will become increasingly clear.
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The MSCI World Index is a free-float weighted equity index. The MSCI World Index (MXWO) includes developed world markets, and does not include emerging markets.
The NASDAQ composite index measures all NASDAQ domestic and international based common type stocks listed on the Nasdaq Stock Market.
The Russell 2000® Index is a market-capitalization-weighted index made up of the 2,000 smallest US companies in the Russell 3000.
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The EURO STOXX 50 is a market capitalization-weighted stock index of 50 large, blue-chip European companies operating within eurozone nations. The universe for selection is found within the 18 Dow Jones EURO STOXX Supersector indexes, from which members are ranked by size and placed on a selection list.
The Nikkei index is a price-weighted average of 225 stocks of the first section of the Tokyo Stock Exchange.
The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The Barclays Aggregate Bond Index is a market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed-rate, publicly placed, dollar-denominated, and non-convertible investment grade debt issues with at least $250 million par amount outstanding and with at least one year to final maturity.
The Barclays Capital Global Aggregate Index Unhedged (Barclays Global Agg Unhedged) provides a broad-based measure of global investment-gradefixed-income debt markets, including government-related debt, corporate debt, securitized debt, and global Treasuries.
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