As we head into summer we thought this would be a good time to provide you our current insights on the equity and bond markets. This has been an interesting year in both equities and fixed income and the remainder of the year should be interesting as well.
This year in the equity markets has been marked by volatility. While 2017 had virtually no volatility, it was the calmest year for markets in more than five decades. Last year, the S&P 500 never moved 2% or more in a day, and yet we have seen a greater than 2% move (either up or down) six times as of April 3rd.[i] Equities markets started 2018 with a bang due mostly to tax reform. The S&P 500 started the year at 2683.73 and moved up over 11%, to 2872.87, by January 26. Then came interest rate worries and talk of trade wars and the S&P 500 has not seen 2872 since. Year to date the S&P 500 is up a little over 2%.
The star of equity markets thus far in 2018 has been small cap stocks. To date, the Russell 2000 (the most widely watched index of small cap equities) is up over 6.5%. This is the first time, in some time, that small cap stocks are leading the market. The Russell 2000 closed at a record high of 1,626.63 on Friday, extending its win streak to three days. This came as the S&P 500 saw its third negative week in the past four weeks.[ii] We have been waiting on this small cap rally for some time. Because of this out performance, our equity portfolios are out performing the S&P 500, so far into to 2018.
All our indicators remain positive in the equity markets and we remain fully invested in our diversified equity portfolios.
The fixed income market seems to be more difficult in this environment. Currently, shorter term interest rates appear to be on the rise. When interest rates go up, the value of bonds go down and we have seen that so far, this year. As the chart below shows, the yield curve is "flattening”, meaning shorter term interest rates are rising while long term interest rates are declining or staying the same.
Historically, if the yield curve flattens and inverts, it tells us that a recession and stock market correction is possible. There appears to be no other economic evidence of a pending recession, in fact the opposite is true. It appears that GDP will cross 3% this year and may stay above 3% for some time. While the Federal Reserve is raising short term interest rates, the market has not responded with a corresponding increase in longer term rates. If the yield curve continues to flatten we could see more volatility in the equity markets.
Our bond portfolio, currently consisting of bond mutual funds, continues to have a relatively low duration (or lower sensitivity to interest rate changes). Currently our bond portfolio has a duration of 3.46 years. Because of this shorter duration, we will have more bonds being repaid and reinvested (at a higher yield) than is typical. This should help reduce the down side risk in the bond portfolio and get the portfolio into higher yielding bonds, quicker.
Overall, we are pleased with the performance of our bond portfolios but we continue to look for ways to decrease down side risk and maintain yield.
We certainly hope you have a great summer and find time to be with family and friends. As always, if we can help, in any way, please do not hesitate to contact us.
viewpointsObservations and Updates from CCA
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