Volatility returned to domestic equity markets during the first quarter of 2018, after remaining at historically low levels throughout 2017. The S&P 500 Index had a strong start to the year, up almost 6% in January, before volatility returned with a vengeance in early February, sparking a mass sell-off. Volatility persisted throughout the remainder of the quarter, with asset prices reacting to a series of crosscurrents, including worries about inflation, the threat of a trade war with China, and the prospect of new regulations on tech firms. These fears contributed to the S&P 500 Index finishing the quarter with a modest loss of 0.8%, just its second negative quarter in the last 6 years.
During the quarter, growth-oriented stocks once again outpaced their value-oriented counterparts. However, in contrast to 2017, small-cap stocks outperformed their large-cap counterparts, with the Russell 2000 Index losing just 0.1% during the quarter. The market sell-off was relatively broad based, with Technology and Consumer Discretionary the only two S&P sectors finishing positive for the quarter, returning 3.5% and 3.1%, respectively. Telecom and Consumer Staples were the worst performing sectors, down 7.5% and 7.1%, respectively.
International equity markets produced mixed results during the quarter. Emerging markets generally outperformed developed markets, with the MSCI EM Index returning 1.4% compared to a loss of 1.2% for the MSCI ACWI Ex USA Index. The United Kingdom and Pacific region had a particularly poor quarter, with the MSCI UK Index and MSCI Pacific Ex Japan Index losing 3.9% and 3.7%, respectively. The U.S. dollar continued to weaken, benefiting U.S. investors holding foreign currencies.
The Federal Open Market Committee (“FOMC”) increased the federal funds rate target by 25 basis points, to a range of 1.50% to 1.75%, during its March meeting. Current expectations are for two more rate increases during 2018, and three further increases during 2019. The Treasury yield curve continued its flattening trend, albeit at a much slower pace than the previous quarter, with the yield on the 2-year Treasury note rising 38 basis points to 2.27%, while the yield on the 10-year Treasury note increased 34 basis points to 2.74%.
The initial estimate of first quarter GDP, released April 27th, was 2.3% growth. Increases in business investment, consumer spending, exports and inventories all contributed to first quarter GDP growth, whilst an increase in imports detracted slightly. Macroeconomic indicators remained broadly positive, with U.S. business confidence reaching a multi-decade high in March.
The unemployment rate held steady at 4.1% during the quarter, while the participation rate improved slightly, from 62.7% to 62.9%. Job gains averaged 222,500 per month for nonfarm payrolls during the quarter. Manufacturing and professional & business services were highlights in the March report, up 22,000 and 33,000, respectively.
The year-over-year headline inflation rate increased from 2.1% to 2.4% during the quarter. This is the rates highest level over the last 12 months and is well above its average rate of 1.6% over the last 10 years. Core inflation (“CPI”), which excludes food and energy, increased from 1.8% to 2.1% during the quarter. The March report showed limited pressure on the CPI, with apparel, education and communications decreasing modestly.
