For the first twenty-six days of 2018 the stock market appeared ready to continue the strong performance from 2017. However, protectionism fears rattled the market as President Trump announced his intention of introducing trade tariffs. This dialogue encouraged nervous investors to sell stocks, take profits, and wait on the sidelines. During the next twelve days the Standard and Poor’s 500 Index lost 10.15% and the correction everybody was expecting, had occurred. Market doomsayers predicted further declines as global trading partners “squared-off” over tariff talk and ten-year Treasury bond yields approached 3%. However, these doomsayers failed to appreciate the strength of the U.S. economy. During the first quarter the companies within the Standard and Poor’s 500 Index (currently 499 of them) reported a year-over-year earnings growth rate of 26.6% versus the first quarter of 2017. The unemployment rate remained at 4.1% and 537,000 new non-farm jobs were created during the first three months of the year. Although, the stock market failed to retrace all of the late January loses, the strong economic fundamentals had placed a “floor” underneath the stock market.
The NASDAQ Composite Index was the only major stock index to generate a positive return (2.59%). During the same period, the Dow Jones Industrial Average (DOW) lost 1.96%, the S&P 500 lost .76%, and the MSCI EAFE International Index declined 1.53%. Even with a soft first quarter, stocks were still able to achieve an above average return for the trailing twelve months ending March 31, 2018. The NASDAQ posted a gain of 20.85%, the Dow was 19.39% higher, and the S&P 500 appreciated by 13.98%. Foreign stocks appreciated as well. The MSCI EAFE returned 15.21% in the most recent twelve months.
In other investible markets, oil continued to become more valuable, a troy ounce of gold required a few more dollars to own, and interest rates marched higher. Just as the new year began, oil prices pierced the $60 per barrel mark for the first time since August 28th, 2015. This was only the beginning as increased demand and a March drop in U.S. crude oil inventories of 4.6 million barrels combined to send oil to $64.54 by the last day of the quarter. Gold remains shunned by speculators in favor of crypto currencies like Bitcoin. The price of gold is range-bound as a troy ounce of the precious metal trades at the same level it did nearly five years ago ($1,300). Interest rates made a meaningful move as the ten-year U.S. Government bond began the quarter yielding 2.40% and ended the quarter at 2.74%.
Looking Forward
In the last quarterly report, D’Arcy Capital identified growth and inflation as more likely to occur than a slow-down and a recession. The economic results in the first quarter of 2018 further supported this thesis. The price of inputs gained (oil, financing, and labor) as unemployment remained low. As a result, inflation increased slightly from an annual rate of 2.1% on 12/31/2017 to 2.4% on 3/31/2018. The increasing input prices will continue for the remainder of the year. The current investment opportunities remain favorable for long-term investors. The S&P 500 price-per-earnings (P/E) ratio has remained at 21 times for the previous seven months. The forward P/E on the same index is only at 17.46 times.
Increasing savings yields have largely “flown under the radar” to most investors. With the Federal Reserve actively increasing the Federal Funds Target rate, investors should implement short-term bond or money market strategies. Two and a half years ago these strategies yielded less than .10%. Today, institutional money markets and short-term bond strategies can yield in excess of 1.50%. Bank savings accounts remain stuck in the low interest mode but investment accounts can provide higher yields for individuals and institutions with high cash balances. The opportunities for high yields should only improve for the rest of 2018 and 2019.
The easy prediction is that financial markets (both stocks and bonds) will continue to see higher levels of volatility. There is no shortage of “noise” that will cause significant fluctuations in the values of stocks and bonds. Daily market changes will be driven by higher interest rates and accelerating political drama as mid-term elections draw near. However, courageous investors who can mute the noise should be rewarded with higher stock values and higher yielding bonds. Having an investment strategy is now more important than ever. The most well-known and popular stocks are expensive and carry a relative high amount of risk. However, there is a majority of stocks that have been overlooked, unloved, or undiscovered that possess lower relative risk and higher return expectations.
D’Arcy Capital is finding opportunities within foreign equities, energy companies, and financial institutions. Artificial intelligence and robotics are emerging as investible industries with enormous upside potential. D’Arcy Capital is currently mining these sectors for an investment suitable for a share of the portfolios. Recently, a Supreme Court ruling opened the door for states to allow gambling on sporting events. This could establish high revenue growth for companies like International Game Technologies and Aristocrat Leisure. Short Maturity, commercial paper and tax-free municipals remain the best option for bond holders. It is still too early in the interest rate cycle to find many opportunities in utilities and consumer staples. Investors should also avoid the top holdings of major index mutual funds and exchange traded funds.
