The first quarter of 2017 was a solid one for stock investors. Large-cap stocks rose over 6.0% in the quarter, as measured by the returns of the S&P 500 index. Historically, election years and the first year of a Presidential term are the strongest for stocks, and 2017 is shaping up to follow the historic pattern.
However, within the stock market, the dynamics have been very different over the past two-quarters. The fourth quarter of last year was also strong for stock market returns, but in a very different way than the first quarter of this year. For example, value stocks and smaller company stocks performed strongly late last year but lagged the overall market this year. International stocks also flip-flopped, going from losses in the fourth quarter to the best performers in this year’s first quarter.
Some of this is likely attributable to the Trump effect. When Donald Trump first took office, there was an enthusiasm in the market for what many perceived to be the ushering in of a new business-friendly era. Corporate and personal taxes would likely be reduced, and onerous regulations rolled back. Stocks soared in reaction, as many of these initiatives appeared supportive for corporate earnings growth.
This year, however, the realities of a fractious Washington, D.C. have set in. Certainly, policy differences between the political parties make it difficult to pass legislation, but even squabbles within the Republican party have derailed some of the Trump agenda. This has led many to question whether the promised reforms and initiatives will indeed come to pass. Stocks have generally held their gains, but riskier parts of the market, such as smaller company stocks and “value” stocks, have sold off somewhat in reaction.
International stocks are also often considered riskier, but actually outperformed significantly in the first quarter. This is because international stock markets offer lower valuations than the U.S. market, making investments overseas more attractive. The relative value that international stocks offer may make them stronger performers than domestic stocks for the next several years. An unusually strong dollar that is starting to give up some of its gains also gave a boost to international stocks in the first quarter and offers further upside going forward.
Bonds posted a significant loss late last year as interest rates rose, but showed a modest gain in the early part of 2017. Again, government policies are likely to credit/blame for this. The Fed has continued to raise short-term interest rates, and long-term rates have generally followed, albeit in an erratic pattern. Also, Donald Trump’s anticipated policies were expected to cause an increase in inflation, which is bad for bonds. Accordingly, bonds sold off a bit late last year, but have recovered somewhat this year as the odds of those policies being implemented are viewed more skeptically.
Alternative investments overall had a solid first quarter. However, there have been spots of strength and weakness lately in these funds. The less liquid funds we hold have performed quite well recently. The more liquid funds struggled last year, but are starting to perk up so far this year. Because our alternative investment portfolio is an eclectic mix of several diverse strategies, it is not surprising to have winners and losers at any point in time. We continue to believe they are an important diversification tool, particularly as stock and bond valuations remain at historically high levels (see related article on stock valuation).
Despite concerns over domestic policy and continued geopolitical worries overseas, the capital markets have produced solid returns so far this year. We still have three-quarters to go to see if the full year holds to the historic pattern for solid gains. However, a low-cost, tax-managed, diversified portfolio provides your best chances for success in any market environment.
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