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Quarter 1, 2018

The market finally hit the pause button this past quarter after nine consecutive periods of gains. There were plenty of theories to explain the modest decline in the S&P 500 index (rising interest rates, fears of global trade wars), but the most plausible explanation was that the market just needed a break in order to catch its breath.  Despite all of the conspiracy theories as to why the market declined, the U.S. economy remains robust and corporate earnings continue to move higher.  Valuation levels remain within their long-term historic range.  Bull markets don’t normally end because of longevity, they end because of economic recession – something which isn’t very likely given the strong state of our current economy.

The March quarter saw a return to more normal levels of market volatility. While 2017 experienced some of the lowest market volatility levels in history, the first quarter of 2018 saw its fair share of market gyrations, both up and down.  Many investors may have been lulled into a false sense of complacency after calm sailing throughout the prior year. The first wake-up call came in early February when the market averages experienced a stomach churning 10% correction off of its recent peak.  Mid-February saw a gradual improvement in the market averages, but the market sold off hard again during the third week of March when fears of a potential trade war with China emerged.  All in all, it was a relatively benign quarter with the S&P 500 index declining just 1%, however there was plenty of drama sandwiched in between.

Corporate earnings are on the rise. Earnings for the S&P 500 index are expected to increase 17% in 2018.  About a third of this gain is attributable to reduced corporate tax rates, but the balance is due to stronger demand for products and services.  Revenue growth for corporate America is now hitting its stride, increasing at a rate which marks its highest growth level in nearly ten years.  A weaker U.S. dollar is also proving to be beneficial as goods produced in America become more price competitive in the global market.  Noteworthy is the fact that companies are experiencing strong growth both domestically and abroad.  2018 should see more industry sectors participating in this better economic environment.  Financial stocks such as banks will benefit from rising interest rates, while energy companies are seeing stronger demand for oil as global economic activity increases.

Growth stocks have led the market higher in recent quarters, while value/dividend stocks have lagged. In general, high dividend paying companies tend to be found in more mature industries and often carry higher levels of debt on their balance sheet.  When interest rates rise, dividend paying stocks are often treated like bonds.  Rising interest expenses means lower earnings for debt laden companies.  We have also recently begun to see a rotation into small and mid-capitalization stocks.  Since small corporations tend to derive a greater proportion of their revenue and earnings domestically, they should reap a greater benefit from the recent tax law changes that were passed late last year. Strong relative earnings growth often translates into strong relative price performance.