2018 Q2 Investment Report Commentary
Things rarely play out the way people foresee them. Take the FIFA World Cup for example, which recently concluded its 21st installment. The tournament began with 32 national teams vying for soccer’s ultimate prize, with tournament stalwarts Germany, Brazil, or Argentina favored to lift the trophy again. Against all odds though, each of these favorites crashed out, eliminated by seemingly lesser teams. No one could have predicted this result or that the tiny nation of Croatia would make the final. However, that is the nature of a contest with numerous potential outcomes; it is unpredictable and full of surprises.
In this way, financial markets are like the World Cup. Both are complex systems that are extremely hard to predict with any recurring accuracy. This was again shown in the first half of 2018, as most market predictions proved wrong.
Right out of the gate, the first quarter shattered the expectation that 2018 would see a continued rise in asset prices as was the case in 2017. Volatility, which had been uncharacteristically low in 2017, spiked in the first quarter of 2018 as the S&P 500 experienced 27 pullbacks over 1%, four over 5%, and one over 10%. The quarter ended with all four asset classes—Equities, Diversifying Strategies, Real Assets, and Fixed Income—in negative territory.
The second quarter’s results were lackluster as well. Even though volatility diminished from the first quarter, it was still higher than the entirety of 2017. In this environment, global equities eked out a 0.5% return. Of course, not every market appreciated. International equities posted negative returns in both developed and emerging markets. Year-to-date though, U.S. equities, as measured by the S&P 500 Index, were up 2.6%, while international equities, as measured by the MSCI ACWI ex U.S. Index, were down 3.8%. From our perspective, investors seem to have a blind-eye toward asset valuation, instead focusing on a small cohort of expensive stocks with extreme revenue growth. While we do not know when this trend will end, history informs us that cheaper assets prevail over the long-term.
Of course, there are many factors at play right now. Since April, the dollar has risen precipitously against a broad basket of foreign currencies and this has eroded the value of most international investments held by U.S. investors. Another development currently weighing on asset performance is the heightened possibility of a trade war. Going into the year, markets did not give much credence to the possibility of a trade war. Beginning in the second quarter though, the White House began placing (or further threatening) tariffs on a significant number of imported goods from multiple nations. Largely due to these currency moves and tariff skirmishes, emerging markets dropped 8% over the quarter, making it the worst performing subsector.