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Second Quarter Investment Commentary

Market Recap

As we pause to reflect at the midpoint of the year, it seems so far 2018 has served as yet another reminder to investors that over the short term, markets are driven by innumerable and often random factors that are impossible to consistently predict. In the first quarter, US stocks experienced their first major losses since 2016 and a return to more “normal” market volatility. Many market prognosticators speculated that this could indeed be the end of the nearly decade-long US bull market.

Fast-forward through three more eventful months and this time around US stocks have been the net beneficiaries, gaining 3.4 percent on the back of a surging dollar while the rest of the world has slowed. The dollar’s 5 percent appreciation translated into a meaningful return headwind for dollar-based investors in foreign securities as foreign currencies depreciated against the dollar. Developed international stocks fell 1.8 percent and European stocks declined 1.6 percent for the quarter. EM stocks fared the worst, dropping 9.6 percent in dollar terms.

In bond markets, the benchmark 10-year Treasury yield pierced the 3 percent level in May, hitting a seven-year high. Yields then fell back, ending the quarter at 2.85 percent, an 11-basis-point increase from the prior quarter-end. As such, the core investment-grade bond index had a slight loss for the quarter and remains in negative territory for the year to date.

Portfolio Attribution

It was a difficult quarter for our equity holdings given the jittery investment climate outside the United States, particularly in the emerging markets. As the global economy began firing on all cylinders for the first time since the financial crisis, our global equity thesis began to play out, with EM stocks gaining 12 percent in 2016 and 32 percent last year. EM stocks then bolted out of the gates in 2018, with an additional 11 percent return through late January. Since then, however, these holdings have declined sharply, and returns are now in negative territory for the year.

The selloff in EM stocks appears to have been driven by a combination of investor concerns about

  • a potential trade war with China (and possibly other global trade partners such as the European Union, Mexico, and Canada);
  • how EM economies will manage a deceleration in global growth outside the United States; and
  • a stronger US dollar coinciding with rising US interest rates and tightening Fed monetary policy.