Stocks maintained their stride in January, despite late-month volatility.
January saw continued strong performance in the U.S. economy, which helped propel domestic stocks to new record heights. As the month drew to a close, the streak of historically low market volatility came to an end and stock markets dipped, giving us a taste of what lay ahead in early February.
2017 was a remarkable year for stocks, both at home and abroad. The first month of 2018 kept the run going with increases across all major classes of stocks. Emerging-market international stocks was the top performing asset class in 2017. It started the year on top as well, with January’s highest return of +8.33% (MSCI Emerging Markets Index). Developed markets saw a more modest, but still impressive, return of +5.02% (MSCI EAFE Index). Domestic stocks performed very well too. Large caps, which we generally weight most heavily in portfolios, rose +5.73% (S&P 500 Index). Mid- and small-cap stocks lagged a bit with returns of +2.87% and +2.53% respectively (S&P 400 and 600 indices). A burst of volatility late in January gave us two days on which the S&P 500 saw returns of +/- 1% — one positive, one negative. Bonds were down for the month as interest rates rose, with the Bloomberg Barclays Aggregate Index off -1.15%.
Why it happened.
Strong initial first-quarter corporate earnings reports helped propel domestic stocks. Continued strong performance in the U.S. economy — both in economic growth and unemployment — contributed to stock performance as well. Longer-term interest rates saw a sharp increase in January. The yield on 10-year government bonds rose from 2.40% to 2.72%. Short-term rates moved up, too, but much less. As expected, the Federal Reserve left interest rates unchanged this month, but markets see an increase in those rates as likely — possibly as soon as March. Bond funds often have exposure to a mixture of both short- and long-term bonds, so they tend to decline when rates rise. Although the brief government shutdown grabbed lots of headlines, it didn’t upset markets.
The late-month announcement that Amazon, Berkshire Hathaway, and JPMorgan were forming a healthcare company sent ripples through the industry. Their partnership aims to reduce healthcare costs for their U.S. employees. Healthcare stocks had slightly outperformed the broader S&P 500 in January up to that point, but the prospect of a new type of competition hit the stocks of health insurers. The entire stock market felt the effects, with the S&P 500 dropping slightly more than -1% over two days. However, healthcare stocks (including drug companies, although they were less affected than health insurers) fell about -3.5%. This event — which was unexpected and hit one particular sector much harder than others — illustrates why diversification across sectors is important. Diversification’s even more important when you hold individual stocks, as you’ll see in this month’s sidebar.
Continued positive economic news in most parts of the world boosted international stocks. Another sharp fall in the U.S. dollar helped domestic investors as well. In 2017, the dollar fell around -10%. In January, it fell another -3% amid some confusion about the current administration’s stance on the dollar. Higher commodities prices helped emerging markets, whose economies are often dominated by the production of raw materials.
How it affects you.
Your portfolio will probably have seen an increase in January. The more investment risk you’re taking — either because you’re further from retirement or you’ve told us you’d like to take on more risk — the better you’ll likely have done. That’s because we’ll have allocated more of your portfolio to stocks. The less risk you’re taking, the less you’ll likely have benefited from last month’s rise in stocks. Also, the fall in bond prices will have had a greater effect on your portfolio.
The volatility that began at the end of January is a good reminder that markets are unpredictable, especially in the short term. The best way to increase the likelihood of meeting your long-term goals is to have a well-diversified portfolio. This portfolio should have a level of risk appropriate for your goals and that makes you comfortable.
At Financial Engines, we build your individual portfolio to meet your unique situation. That’s why the more you tell us about yourself and your goals, the better we can tailor your portfolio to you. Talk to one of our advisors if you have questions about your portfolio or if recent volatility has you concerned. And please let us know about any changes to your personal situation. We’re here to help.