Most equity markets fell in March and volatility remained elevated. Information technology (IT) stocks declined sharply, but remained the top performing sector in the S&P 500 on a year-to-date basis. Unlike February, dispersion was high as some sectors posted positive results amid the broad equity market sell-off. Longer-term U.S. interest rates fell, reversing some of the sharp increases from earlier in 2018. This provided a tailwind for bonds and some rate-sensitive equities, such as utilities and REITs.
Uncertainty regarding potential tariffs and a rise in protectionist policies were also at the forefront. In early March, President Trump made a surprise announcement that the U.S. would impose tariffs on steel and aluminum imports. Later in the month, details emerged that several countries would be exempt from the tariffs. Unsurprisingly, China retaliated with an announcement of additional duties it would impose on select imports from the U.S. Fears of a deepening trade war grew as rhetoric between the U.S. and China extended into April. Although some point to the rhetoric as being the opening salvos of a trade war, much could change as negotiations continue. Furthermore, the ultimate impact of protectionism on trade, global growth, and specific company fundamentals remains unclear. For the month, the Dollar Spot Index fell modestly and currency did not have a meaningful impact on non-U.S. market returns for U.S.-based investors.
The Russell 3000 Index, a broad proxy for domestic equities, fell 2.0% in March, posting its second consecutive monthly decline for the first time since early 2016. Only three of the 11 GICS sectors in the Index recorded positive performance. Financials (−3.2%) reacted unfavorably to lower long-term yields, with money center banks Wells Fargo (−10.3%), Citigroup (−10.6%), and Bank of America (−6.2%) among the notable detractors.
The sell-off of IT stocks (−3.3%) reversed a strong start to the year, as concerns about increased government regulation mounted in the aftermath of the Facebook/Cambridge Analytica scandal. By month-end, Facebook (−10.4%) was narrowly surpassed by Berkshire Hathaway as the fifth largest benchmark component after Apple, Microsoft, Alphabet (Google), and Amazon. Despite declining sharply from its mid-month high, Amazon was only down 4.3% on the month and finished the quarter as the eighth-best performing stock in the S&P 500 with a gain of 23.8%. Fellow consumer discretionary name Netflix posted a slight gain in March, bringing its YTD gains to 53.9%—the second highest return among Index constituents. Aside from Amazon and Netflix, the broader consumer discretionary sector struggled on the month and the year, in large part fueled by continued weakness in the retail space. Materials (−3.6%) was the worst-performing sector, as fears of escalation in protectionist rhetoric concerned investors by introducing doubt into the sustainability of the positive global backdrop.
For the same reason, domestically oriented small cap stocks bested their large cap counterparts, with the Russell 2000 Index gaining 1.3% versus a 2.3% decline for the Russell 1000 Index. The strength of the energy and utility sectors more than offset the weakness in financials and helped propel value stocks ahead of growth stocks. In addition to weakness in financials, underperformance in the IT sector was another headwind for growth equity indices. Growth-oriented companies suffered during the month after being the largest positive driver of equity market performance in 2017 and the start of 2018. For the month, the Russell 3000 Growth Index fell 2.4% compared to the 1.5% decline of the Russell 3000 Value Index.
Despite the decline in broad equity markets, marketable real asset categories generally performed well, with REITs advancing 3.9% (FTSE EPRA/NAREIT US Index) and energy rising 1.8% (North American Natural Resources Index). Solid overall earnings in the REITs sector and a decline in Treasury yields (a benchmark for REIT yields) drove gains. The advance was led in part by the net lease (+5.1%) and health care (+5.9%) subsectors which have long duration bond-like leases and are viewed by some investors as a fixed income alternative. The rally marks a reversal from the first two months of the year, when U.S. REITs declined 11.2% on a combination of factors. This included rising interest rates and the concern that rates may climb faster than expected, pockets of oversupply and softening fundamentals in select markets and sectors, and growing concern about the impact of e-commerce on brick and mortar retailers. On a YTD basis, U.S REITs are still down 7.8%, with retail REITs (−11.2%) and bond-like health care REITs (−10.9%) amongst the largest decliners.
Energy equities gained 1.8%, trading higher along with stronger crude prices. Spot oil prices rose 5.4% on robust global demand and growing sentiment that Organization of the Petroleum Exporting Countries and Russia may extend production cuts through 2019. Along with reductions in output, rising geopolitical concerns were also supportive of higher prices, notably concerns that the U.S. may renew sanctions against Iran and that Venezuela’s economic crisis may cause further declines in that country’s output. Crude prices rallied 7.8% YTD and 28.9% over the trailing 12-month period. On a YTD basis, the energy sector produced the highest year-over-year earnings growth (+81.3%) of all sectors in the S&P 500. Despite several quarters of strong earnings and relatively stable or increasing oil prices, energy equities are down 6.9% YTD as investor sentiment toward the sector remained negative.
Equity market volatility, as measured by the VIX Index, ended the month at 20.0—nearly double the 2017 year-end level (11.0)—due in part to the aforementioned IT sell-off and uncertainty surrounding proposed trade tariffs with China. According to Morgan Stanley Prime Brokerage, many long/short equity funds have sought to take advantage of the recent volatility by adding to high conviction names. Elevated volatility may benefit long/short equity hedge managers as it creates dispersion among winners and losers, providing long/short funds the potential to profit from both long and short positions.
In March, the majority of long/short managers held up well, posting flat performance despite the dip in the market and the overweight technology exposure. Facebook is a widely held position among long/short equity funds. Other IT stocks such as Qualcomm (−14.8%), JD.com (−14.1%), Alphabet (−6.6%), Amazon (−4.3%), and Altaba (−1.1%) were also detractors for many managers. Offsetting these losses were positions such as Constellation Brands, Transdigm, and Autodesk, which all rose by more than 5.5% despite the broader equity market sell-off. Many managers also benefited from short positions in the health care and retail sectors. For example, short positions in names such as AbbVie (−18.3%), Express Scripts (−9.7%), and Amgen (−7.2%) fell sharply and rewarded short holders.