Adventures of an Investment Road Trip
The first quarter of the year has been quite an adventure for investors. We have become accustomed to smooth rides founded on moderate economic growth, very favorable interest rates and on the hopes of better times ahead that have been able to absorb various political and economic disruptive events. The first quarter served as a reminder that on our investment road trip, we will on occasion encounter periods of turbulence. So, are there points of information that can be gleaned from the first quarter that may prove to be helpful as we navigate the rest of the year on our investment journey?
At one point in the first quarter, stocks – as measured by the S&P 500 – were nearly 7.5% higher than where they began the year. Then, in an abrupt about-face, stocks took an over 10% nosedive and things were feeling a bit skittish at best. Some stability was found and by the end of the quarter stocks were just .12% lower than where they began the year – that is a lot of distance for a round trip!
We thought stocks could move about 10% higher over the course of this year. We are going to temper that expectation a bit by inserting an 8-10% range to our forecast. With dividends included, we still think we should come out around a 10% rate of return for stocks over the course of the year. The backing and filling action from stocks thus far is a good thing in our opinion and the underlying fundamentals for stocks are still favorable and should allow us to enjoy positive rewards for our investment over the course of the year.
Interest rates finally began to move up in earnest during the first quarter of the year. The U.S. Central Bank, the Federal Reserve, seems to have caught investor’s attention with their clear intent to continue increasing short term rates and their message is being validated by a strong employment environment and a healthy economy. Interest rates, as measured by the 10-year U.S. Treasury Note, moved from a 2.41% yield at the beginning of the year to as high as 2.95% during the quarter before settling back down to a 2.75% yield. The rise in rates was in our opinion, the catalyst for starting the angst we witnessed in the stock market.
We expect the Federal Reserve to follow through on their guidance for two more bumps up in the discount rate over the course of this year. That would move the prime rate from its status of 4.75% to a rate of 5.25%. We anticipate 30-year mortgage rates to move higher as well, somewhere near 5% by year end. We forecasted the U.S. 10-year Treasury Note to move up to a yield of 3 - 3.25% by year end and we feel that is still the most likely scenario at this point. However, we expect the next .50% increase in yield to play out over the course of the year rather than in such an abrupt move as occurred in the first quarter.
We continue to believe economic growth in the United States will average over 3% for the 2018 year. The tax cuts should prove to be beneficial to both consumers and businesses and that coupled with a high rate of employment ought to serve as the base for a healthy foundation for the economy to grow on.
There are always a few unknowns that can affect our outlook. The two unknowns we are most concerned about are trade wars and the pace of inflation. First, trade wars – President Trump has a unique negotiating style and whether it will be effective is anyone’s guess. Perhaps the negotiating style of shoot first and then aiming will generate the desired results. Maybe the sabre rattling of trade war talk will bring nations together and produce some positive fruits from their discussions. However, it will be necessary to recognize that all sides will need to be willing to compromise for a better “deal”. When you “bully” negotiate, it can make it harder to accept that the other side may have some legitimate points of contention.
Second, inflation – we believe inflation will gradually rise over the course of the year and certainly reach the Federal Reserves stated desire rate of 2% by year end. Things like trade wars can put a wrench in the process and end up accelerating the rate of inflation and blunting growth. We will keep a close eye on the inflation rate – a little now is a good thing; but, like everything, too much of something is not a good thing.
We truly appreciate the opportunity to work with you – We hope this spring season will be enjoyable for you!