Summary of 1Q/2018: Volatility Is Back!

If we could summarize the first quarter of 2018 in a single word, it would, of course, be volatility. This was all too obvious from the repeated headlines and the screaming CNBC pundits. To quantify it, the measure of daily volatility used in the Black-Scholes option pricing equation was up an astonishing 3.6-fold over the prior quarter. However, like a roller coaster, the endpoint was not that far from where the ride began, with one notable exception (US Real Estate). Some of the crazy days were explained by anticipated changes in future Federal Reserve behavior while others appeared to spring from Trumpian talk of trade wars. The table below summarizes the estimated returns for various asset classes based on the performance of Vanguard index funds. Please note that they do not represent the returns of the funds or portfolios recommended by Clarity Capital Advisors.

Asset Class           Ticker Used          1Q/2018 Return   

US Total Market       VITNX                        -0.6%                         

US Large Growth     VIGAX                         1.2%                        

US Large Value       VVIAX                         -2.3%                         

US Small Growth     VSGAX                        2.1%                         

US Small Value        VSIAX                        -2.1%                         

International             VTMGX                      -1.1%                         

Emerging Markets    VEMAX                       2.1%                         

US Real Estate         VGSLX                        -8.1%                         

Int’l Real Estate        VGRLX                        0.4%                         

US Bond Market       VBTLX                       -1.5%                         

US TIPS                     VAIPX                       -0.9%                         

Interestingly, although we heard a great deal of disparaging talk about the technology sector, especially concerning Facebook, the information technology sector was up 4.1% (based on VITAX), and it was one of the drivers of the superior performance of growth over value. One of the weaker areas of the US market was real estate investment trusts (REITs) with an 8.1% decline which is partially attributable to an increase in long-term Treasury yields of about 0.24% because REITs possess a degree of term risk resulting from their high dividend yields. The increase in interest rates also shows up in the negative bond returns seen above. The dollar continued its weakening trend, losing about 2% relative to a basket of foreign currencies. Nevertheless, international developed equities, unlike emerging markets, were still down for the quarter.

Given that the Federal Reserve is no longer supporting asset prices through its Quantitative Easing program, we are now on our own. With a strong US and global economy that is operating at full employment, aside from political risks, the biggest risk to investors appears to be unexpected inflation. For now, inflation appears to be under control with the 10-year breakeven inflation rate holding around 2%. As for whether we expect the increased volatility to continue, we turn to the CBOE Volatility Index (VIX), which ended the quarter just under 20 which is about 80% higher than where it began but quite a bit lower than its quarterly closing high of 37. From this we infer that the market expects higher-than-pre-2018 volatility but perhaps not as high as we experienced in the first quarter. Time will tell!