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Trust presents Q2/2018 portfolio review and strategy

By Staff | May 11, 2018
Craig Hoston

Global stock markets moved modestly higher during the first quarter of 2018. For the first time in more than a year, day-to-day stock market volatility has returned to historically normal levels. Last year was unusually calm as markets moved steadily higher throughout most of 2017 with minimal interruption. In fact, 2017 was the least volatile stock market year since the CBOE’s Volatility Index was established in the early 1990s. With that context, we view recent stock market movements as rather normal. We encourage our clients to avoid focusing on the short-term market “noise” and instead look to the fundamentals of the economy and the companies we follow. From our perspective, corporate earnings were quite strong in the fourth quarter of 2017, which portends well for this year and next, particularly when you factor in the tailwind of corporate tax reform.

On March 21, the Federal Reserve Board announced their decision to raise the federal funds rate by another 0.25 percent. The Fed will also continue to reduce the size of their balance sheet by letting Treasury and mortgage-backed securities mature over the next few years. This was largely anticipated by most market participants. Nonetheless, it is another signal that monetary “tightening” clearly is occurring. Other broad market interest rates have responded this year by moving higher. In the near term, higher interest rates will put price pressures on dividend-paying companies as the relative value between income-producing stocks and bonds readjusts. Though we continue to view higher interest rates as a symptom of a positive overall economy, we will continue to watch the shape of the yield curve. An inverted (negative sloping) yield curve generally portends poorly for economic activity. We have seen some flattening in the curve over the past year as short-term interest rates have risen faster than long-term rates.

For the first time in years, bond investors are starting to feel the impacts of higher interest rates. Bond prices have moved lower in 2018, and that will continue as long as interest rates continue to move higher. The biggest impact will be felt by investors holding long-term bonds – an asset class we have avoided for years. Short-term bonds will also be impacted, but to a much lesser extent. Our investment team is watching these movements closely and will continue to evaluate the relative value between stocks and bonds as interest rates move higher. For the time being, we believe we are still a long way away from bonds being as attractive as stocks on a risk-adjusted basis. However, as rates rise, our willingness to use bonds in a more meaningful way across client accounts will increase.

Craig J. Hoston is the chief operating officer for the Sanibel Captiva Trust Company.