Investor sentiment was notably positive coming into 2017 and U.S. markets built on this momentum in the first quarter, pushing key indexes to reach all-time highs during the period. However, the rally halted late in March after the new administration failed to repeal the Affordable Care Act. The Dow Jones Industrial Average fell for eight consecutive sessions, stemming from investors’ skepticism about the Republican Party’s ability to get other initiatives passed quickly through the legislature. Even so, benchmarks ended in positive territory for the past three months.
A synchronized pickup in global economic activity supported risk appetite during the quarter. Most asset classes generated positive returns, led by high yield credit, equities, and unhedged emerging market bonds. The Federal Reserve (Fed) raised rates in March, a widely anticipated move that acknowledged the strengthening U.S. economy. Corporate profits improved and volatility remained very low. Commodity performance was mixed; metals rallied while oil prices dropped.
The U.S. high yield credit rally that began in 2016 continued into the first quarter, with spreads (the difference in yield between Treasury and non-Treasury securities of similar duration) reaching multi-year tights in early March. Though spreads widened somewhat during the last weeks of the quarter, the asset class handily outperformed Treasurys of similar duration (duration refers to a security’s price sensitivity to interest rate changes).
U.S. Treasury yields reached year-to-date highs ahead of the Federal Reserve (Fed) interest rate hike, then retreated to finish the quarter essentially flat. The yield curve (a curve that shows the relationship between bond yields across the maturity spectrum) flattened as shorter-maturity Treasury yields rose while longer-maturity Treasury yields were nearly unchanged.
All asset classes – fixed income, Canadian equities, and global equities – produced a positive return in the first quarter. Equities continued to advance higher, with the MSCI World Index, up 5.8%, outperforming S&P/TSX Composite Index, which was up 2.4%, following an excellent performance in 2016. The FTSE Canada Universe Bond Index returned 1.2%, a significant rebound from the -3.4% return seen in the fourth quarter of 2016.
The final revision to 2016 fourth quarter U.S. GDP was released in March and showed that growth slowed to a 2.1% annualized rate, after showing a marked acceleration in the third quarter of 2016. However, personal consumption remained surprisingly strong, as consumer and business confidence indicate a level of optimism not seen in 15 years. The optimism and enthusiasm around prospects for the new administration quickly succumbed to the realities of politics, as the first major attempt to reshape the U.S. government stumbled over the health care initiative. This setback has dampened expectations for extensive tax reform and additional stimulus programs. Nevertheless, there is still a large disparity between “soft” survey data, which reflects a high degree of optimistic sentiment about the future, and the “hard” data that reflects low to moderate economic growth.
Volatility returned to U.S. equity markets as investors began to question the ability of President Trump to fully implement his pro-growth agenda. The S&P 500 Index reached a new all-time closing high of 2395.96 on March 1. However, equities started to drift lower as opposition to the American Health Care Act of 2017 (AHCA) increased while crude oil prices fell below $50.00 a barrel. The S&P 500 experienced its first 1%* decline since October 2016 on March 21as it became apparent the AHCA would not have the votes to pass through the House of Representatives. Equities recovered in the month’s final week as President Trump immediately shifted his focus to tax reform. Small-cap stocks measured by the Russell 2000 Index gained 0.13%* and barely outperformed large-cap stocks as represented by the S&P 500, which rose 0.12%*.
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