Market Reflections for Second Quarter 2018

Calling the second quarter of 2018 “eventful” would be an understatement. On one hand, we had inflation pressure continuing from previous quarters that led to the Federal Reserve raising the Federal funds rate by another quarter of a percent in June. The U.S. dollar appreciated against the currencies of most emerging-market and developed countries, dragging down returns for U.S. investors in overseas markets. Meanwhile, the looming trade battle continued, with Europe, Canada, Mexico and China threatening to retaliate by imposing their own tariffs against U.S. imports. Despite these overhanging clouds, the U.S. economy is on strong footing — the unemployment rate is at a historic low (4.0% as of June1) and wage growth is increasing (2.7% as of June2). Business fundamentals are very strong, with the first-quarter earnings growth rate at approximately 25%.3

Returns shown in the chart above are for second quarter 2018.
Source: Morningstar®, data as of June 30, 2018.

The U.S. equity market, while volatile, posted solid performance in the second quarter, supported by positive earnings momentum and strong economic data. U.S. large-cap stocks, represented by the S&P 500 Index, ended the quarter with a sizable 3.4% gain. Small-cap stocks were the strongest performers with the Russell 2000 Index (which represents small-cap stocks) returning +7.8%, surpassing most other indices. This partially can be explained by international trade concerns weighing more heavily on large-cap stocks that have a global presence, rather than on small-cap stocks. Growth stocks continued to outperform value stocks among large caps, with the Russell 1000 Growth Index up +5.8% versus the Russell 1000 Value Index return of +1.2%. The outperformance of growth stocks was led by solid returns from growth-oriented sectors such as consumer discretionary (+8.2%) and information technology (+7.1%), of which FAANG (Facebook, Amazon, Apple, Netflix and Alphabet, also known as Google) stocks were the main contributors.

We experienced headwinds on the international front this quarter, as both international-developed and emerging-markets equities declined. The appreciating U.S. dollar dragged down returns for U.S. investors in overseas markets. International-developed stocks, represented by the MSCI EAFE NR Index, gained 3.5% in local currency terms but fell 1.2% in U.S. dollar terms. In addition to the currency factor, trade war concerns also weighed on European equities, though not as hard as they weighed on emerging-markets equities. The MSCI Emerging Market Index was down by 3.5% in local currency terms but declined 8.0% in U.S. dollar terms.

On the fixed income side, the Federal Reserve raised rates again in June, which signaled their confidence that the economy is on the right track, and indicated that it will likely hike rates two more times in 2018. Since the end of the first quarter, the 2-year Treasury yield rose from 2.27% to 2.52%, and the 10-year Treasury yield rose from 2.74% to 2.85%, which resulted in further flattening of the curve. As rates rise, bond prices decline; the Bloomberg Barclays Aggregate Index, representing investment-grade U.S. bonds, declined slightly by 0.2%. Municipal bonds (BBgBarc Municipal 1-10Y), which tend to be less sensitive to rising rates than U.S. Treasurys, regained traction after a turbulent first quarter, gaining 0.8%.

Source: Morningstar®, data as of June 30, 2018.

After five consecutive quarters of strong performance, emerging-markets debt encountered the strongest headwinds among all asset classes this quarter. The JPM GBI-EM Global Diversified Index (UH) declined 10.4% in the second quarter of 2018. As in other international markets, the strong dollar weighed heavily on returns; the Brazilian real, Turkish lira and South African rand each depreciated by over 13% against the U.S. dollar (in the second quarter alone). Emerging-markets debt is becoming an increasingly important part of the global investment spectrum, given the improving credit profile and quality of financial markets in emerging-market countries. Therefore, despite the unfavorable current market conditions, we believe in the long-term attractiveness of this space. Meanwhile, high-yield bonds, represented by the ICE BofAML BB-B US CP HY Index, showed more resilience and returned +0.7% for the period.

The U.S. equity market was the lone bright spot in the second quarter, as international markets suffered due in large part to dollar strength. A globally diversified portfolio that benefited from international exposure over the past several quarters felt the opposite effects in the recent period. Currency movements are unpredictable and can have a significant impact on short-term results. However, over the longer term, evidence shows that the impact of currencies on portfolio returns tends to even out, and that a portfolio with exposure to international markets can reward long-term investors.

 

U.S. Stock Market: Russell 3000 Index
International-Developed Stocks: MSCI EAFE NR Index
Emerging-Markets Stocks: MSCI EM NR Index
U.S. Bond Market: Bloomberg Barclays Aggregate Index
Emerging-Markets Bonds: JPM GBI EM Global Divers TR Unhedged

Return data represent past performance and are not indicative of future results. Historical returns of indices do not reflect applicable transaction, management or other applicable fees, the incurrence of which would decrease historical performance results. Index information has been compiled by Wipfli Financial from sources Wipfli Financial deems reliable, but has not been independently verified. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only. Indices are unmanaged. It is not possible to invest directly into an index. Any charts and graphs represented herein are for informational purposes only and cannot in and of themselves be used to determine which securities to purchase or sell, or when to purchase or sell securities.

Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services and fees is set forth in Wipfli Financial’s current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Rafia Hasan
Rafia Hasan

CFA, CFP® | Chief Investment Officer

Rafia Hasan, CFA, CFP®, is the Chief Investment Officer for Wipfli Financial Advisors, based in Chicago, IL. Rafia leads Wipfli Financial's Investment Committee and has a deep knowledge of the financial markets, specifically in the areas of alternative investments and private equity. She also specializes in personal financial planning and estate planning for women investors.

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Market Reflections for Second Quarter 2018

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