- The S&P 500 had its first negative quarter since Q3’15.
- Volatility returned to the markets in February and stock indexes have traded in wider ranges since.
- Heavily weighted Technology stocks, which led the bull market higher post-election, had marginal gains for Q1 but remained the leading sector. FAANG stocks in particular came under pressure late in the quarter.
- Tariffs and fears of broader “trade wars” hurt stocks and helped drive small cap outperformance in March.
- Safe havens and defensives outperformed while pro-cyclicals including Financials and Materials underperformed.
- Outside of Tech, consumer discretionary was the only sector that finished positive in the first quarter.
For the second consecutive month the Dow Jones Industrials, S&P 500, and the Nasdaq Composite indices finished in the red amidst the backdrop of broad, volatile price action with big percentage moves in both directions, driven by a chorus of fresh concerns and events. All three indices rebounded between 2% and 3% in the final week of March, however that proceeded declines in each of the prior two weeks with the latter being the largest weekly selloff in more than two years.
Whereas February’s correction was sparked by rising inflation data and calls for increased rate hikes, March’s madness included tariffs on aluminum and steel, fears of broad trade wars, rising Libor and funding costs, a flattening yield curve, and concerns of consumer regulation engulfing Big Tech. Sprinkle in the abrupt departure of the President’s top economic advisor, and his ousting both the Secretary of State and National Security Advisor, there was plenty of blame to go around.
The Dow Industrials and S&P 500 ended a streak of nine consecutive quarters in the green, and for the S&P 500 its first Q1 decline since 2009. The Nasdaq 100 (NDX) had its worst monthly decline since January 2016 and ended the month with six consecutive sessions moving 1% or more. Yet despite the stormy weather, green shoots can be seen entering the first full month of spring. The major equity indices are now retesting their early February lows which could be setting up a large double bottom reversal, similar to the correction lows made in the summer of 2015 and Q’16. The small and mid-caps actually had positive returns in March, North Korea suddenly wants to talk peace, but most importantly, earnings.
The small cap Russell 2000 and midcap S&P 400 indices were the only two majors to close out March in the green with monthly gains of 1.1% and 0.8%. Both were rebounding from steep 4% plus losses in February, however their outperformance was likely due more so to their reduced international exposure, thus making them more attractive in an environment of tariffs and escalating trade wars. The worst performers were the Nasdaq 100 (NDX) and Dow industrials which declined 4% and 3.7% respectively, followed then by the Composite, (2.9%), and S&P 500, (2.7%).
The late quarter profit taking in large cap technology was induced by unique concerns regarding driverless car safety, government regulations related to consumer data and privacy, and higher postage taxes for online transactions. This drove the Nasdaq 100 to its worst monthly decline since January 2016. And while the rout in technology may have been the biggest standout in March given the group’s previous leadership role since the start of 2017, financials and materials were actually the worst performing sectors which attributed to the underperformance of the Dow Industrials. For the quarter the Composite and NDX were the only two indices in positive territory with gains of 2.9% and 2.3%. Conversely the Dow Industrials was the biggest laggard losing 2.5%.
In textbook fashion the broad risk-off environment created high demand for safe havens, outperformance by the defensive sectors, and underperformance by the pro-cyclicals. Utilities and REIT’s led with gains of 3.4% and 3.3%, ending a streak of three consecutive months in the red. Along with better valuations from their recent declines, both high yielding sectors benefitted from the reversal lower in interest rates. Since peaking in late February the 10-yr Treasury yield had been making a series of lower highs, but had consistently found support along the 2.80% level. That changed in the final days of March when the long yield broke support and closed the month down at 2.734%. The technical breakdown projects a measured move towards the 2.60% - 2.64% range which already in April is less than 10bps away.
After a stunning 11% decline in February, the energy sector stabilized in Marchwith a gain of 1.6%. The sector has traded in a tight sideways range since about February 8th, the longest such stretch in at least five years. The headwinds in February were earnings and a near 5% decline in crude oil, but those dynamics changed in March. Most energy companies reported earnings in February, while WTI crude rose 5.3% in March. For Q1 WTI gained 7.5%, its third consecutive quarterly advance and the first time that has happened since late 2010.
While declining rates were a tailwind for the defensive groups, it was a dark cloud for financials. The fins were the worst performing sector dropping 4.5% in March. While NII/NIM’s have been aided by rate hikes, the rout in equities and moderate inflation data tempered hawkish expectations about the pace of future hikes. In addition the longer end of the yield curve (2yr – 10yr spread) closed the month at its lowest level since late 2007. And the belly of the curve (the 3month - 2yr spread), a better NI barometer for pure branch bank lenders, flattened 20bps from its Q1’18 highs made in late January. On a positive note the “belly” remains more than 30bps above its 52-week lows made last summer.
Technology was “merely” the third worst performing sector with a monthly decline of 3.9%, yet it was the biggest standout given (1) its role as the market leader since the start of 2017, and (2) it is 25% of the weighting in the S&P 500, by far the biggest sector. The five largest technology companies alone account for ~15% of the S&P 500. On a positive note, technology companies in the S&P 500 are expected to report 22% YoY earnings growth in Q1, according to Factset.
Consumer Discretionary gave back 2.5% for the month despite seeing U.S. consumer sentiment surge mid-month to its highest reading since 2004. The University of Michigan report showed softening attitudes at the end of the month as the reading declined following tough trade talk rhetoric out of Washington D.C. The S&P 500 Retail Indexdeclined 2.65% for the month but posted an 11.3% gain for Q1’18. The S&P 500 Consumer Discretionary and Technology indices Index were the only sectors to posted positive returns in Q1’18 with gains of 2.8% and 3.2%. Consumer spending is an important factor in U.S. GDP and any signs of strength there should be viewed as a positive for the economy.
Materials and industrials declined 4.4% and 2.8% due in part by tariffs imposed on steel and aluminum, and fears of a growing trade war between the United States and China. Both groups moved sharply higher following the November 2016 elections and the gains continued unabated until the last two months. The first quarter of 2018 was the first quarterly decline for both sectors since 3Q’15; industrials lost 2.0% and 6 % for materials. The Trump infrastructure plan was also expected to be a huge windfall, but it now seems stalled.
The first quarter of 2018 started much like 2017 ended. Technology stocks led the equity markets higher and volatility, which hit record lows in Q4’17, remained at low levels throughout much of January. In early February however, a strong payrolls number sparked worries about wage cost inflation that might cause the Fed to increase interest rates at a faster pace than expected. At the same time, significant losses in certain ETFs that profited from bets against volatility spooked investors. “SVYX” lost over 80% of its value in one session and “XIV” was liquidated after volatility as measured by the CBOE VIX Index (“VIX”) spiked from a closing level of 17.31 on Friday February 2, 2017 to over 37 on Monday February 5, 2017. After falling by 666 points on February 2, the Dow fell an additional 1,175 points. The 7% decline in the S&P 500 and volatility spike over two days signaled to investors that something had changed. The VIX’s average close was 17.25 during 1Q’18 vs. 10.30 during 4Q’17.
According to Nick Colas of DataTrek, the S&P had 23 daily moves of 1% or more in Q1, compared to eight such days in all of 2017. The Q1 average since 1958 is 13. During the nine other years with similar 1Q volatility, the following quarter was up 1.9% and stocks rose 6.1% for the full year. So, while there may be more volatility ahead, this does not necessarily mean stocks will move lower.
Q1 earnings season will begin shortly and expectations are high. The S&P 500 is expected to grow earnings 18% - 20%, according to Factset and Thomson Reuters. This compares to the long-term average yearly increase of about 7%. Strong earnings growth is already baked into stock valuations so any disappointments could hurt stock prices.
And although a fair amount of economic data has been coming in below expectations throughout most of Q1, the data has been solid. The Atlanta Fed’s GDPNow model is currently estimating 2.8% real GDP growth for Q1’18 . While this estimate changes regularly, and Q1’s range has fluctuated between 1.8% and 3.5%, it is well above the 0.4% average the U.S. economy has posted in Q1 since emerging from the Great Recession.
The capital markets appear to remain healthy. Although the yield curve is flattening, it is far from being inverted. Credit spreads between high yield and treasuries are tight by historical standards, and according to LPLA Financial, the dispersion within high yield is actually improving.
Meanwhile the IPO market is strong. March saw 14 new listings make their debut on Nasdaq bringing the total number of initial public offerings on Nasdaq to 37 for Q1’18, raising nearly $7 billion. Some of the larger companies included iQIYI (IQ), Dropbox (DBX) and Bilibili (BILI). For comparison in Q1’17 Nasdaq listed 17 IPOs raising $3.5 billion. This year has been the best start for IPO’s since 2014 when Nasdaq saw 189 new listings raising nearly $22 billion. In the 1st quarter of 2014, Nasdaq listed 47 companies raising $3.43 billion.
Lastly, one liquidity measure that has been getting attention is the “Libor-OIS” spread. Some market watchers worry that the growing difference in interest rates between LIBOR (a “private” rate banks charge each other for overnight loans) and “overnight indexed swaps” (a risk free rate similar to Federal Reserve rates) might indicate tighter financial conditions or even stress in the marketplace. Spikes in this measure are not uncommon but there have been past instances where such a widening preceded financial problems in the economy. Although there are widely reported concerns about the fast-widening LIBOR-OIS spread, there are mechanical reasons that may explain this measure, and at this time credit markets are not confirming any funding stress.
6-mo. Chart of U.S. LIBOR-OIS Spread:
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Nasdaq's Market Intelligence Desk (MID) Team includes:
Michael Sokoll, CFA is a Senior Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over 25 years of equity market experience. In this role, he manages a team of professionals responsible for providing NASDAQ-listed companies with real-time trading analysis and objective market information.
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