Investment Outlook
Q1 2018
Market Commentary

After the S&P 500 recorded positive returns for nine consecutive years at the end of 2017, volatility in many stock market indices shook up the market's complacency in the first quarter of 2018. January's celebration of the benefits of the Tax Reform and Jobs Act proved to be short-lived, as both February and March produced negative returns for U.S. stock markets. This was the first full quarter market decline since the summer of 2015.

The reasons for the weakness were different in each month — February witnessed the comeuppance of strategies shorting VIX (the predominant short-term stock market volatility index) futures and March ushered in fears of the negative impact of trade disputes led by the current administration. The damage from the spike in volatility in February was itself well contained and short-lived, but it reflected the high level of complacency in future market dynamics with investment strategies relying upon the supposed "permanent" low level of stock market volatility. In our view, the abnormally low level of the VIX was never permanent, and the stock market has settled into a higher range of future volatility that seems much more appropriate. As funds that shorted VIX futures had to cover positions (and therefore sell stocks), it did not take long for such investors to get wiped out and the downside pressure on stocks to come to an end.

In last quarter's commentary, we identified negative trade actions as a key risk to the stock market and the economy. We've seen these dangerous actions gather momentum in March, as the U.S. announced its decision to impose tariffs of 25% and 10%, respectively, on steel and aluminum imports. The rhetoric of the President and his trade advisers has continued to add to concern, not lessen it. However, a few modifications to the trade agreement with South Korea, possible progress in renegotiating NAFTA with Canada and Mexico, and ongoing "discussions" with China could result in improved outcomes. But the risk of igniting a trade war is being weighed by the market, and investors don't like such uncertainty. If the Trump Administration had just left well enough alone, with the cuts in taxes and regulations, the market may have sustained a recovery from February's decline. Instead, trade war fears turned the quarter from a gain to a loss for equities. As stated last quarter, we will continue to monitor these developments and take appropriate action when necessary.

In addition to these events, high-priced information technology stocks took a hit due to their association with Facebook. Growth-oriented stocks, like the technology leaders in the highly-touted FAANG group (Facebook, Amazon, Apple, Netflix, and Google), had led the S&P higher into 2018, but the news coverage regarding the invasion of user privacy at Facebook sent most of these stocks down in March along with the tech sector as a whole.

While there is little indication, based on the various leading and contemporaneous measures of economic performance, that the economy overall has been negatively impacted by these events, the decline in Treasury bond yields during March once again signaled that fear has risen. Rising interest rates that accompanied strengthening economic momentum had not hurt stocks, and conversely, the recent fall in yields did not help stocks, except the most interest-sensitive sectors.

With Jerome Powell newly at the helm of the Federal Reserve Board, the impact of monetary policy shifts are being hotly debated. We remain in uncharted territory in terms of the potential impact of rising short-term interest rates after eight years of the Fed's zero interest rate policy. Powell appears to be on the same course as his predecessor Janet Yellen with plans to raise the Fed Funds rate at least two more times in 2018 and again in 2019. The normalization of short-term rates back to or above 2.5% does not, in and of itself, pose a danger for economic growth. But as we've seen with corporate borrowing and imbedded leverage in market investments like VIX shorting, the pace of change could be disruptive to markets and perhaps the economy even if higher interest rates ultimately reduce excessive risk taking.

This increase in troublesome events in the stock market's calculus of future trends has recently driven the stock market down, and at the same time, the decline has seemingly wiped out the perceived benefits of tax reform. These benefits have not gone away, and if an all-out trade war is avoided, today's weakness will turn into tomorrow's strength. Although caution is warranted, we have not overreacted to the market's concerns by making radical portfolio shifts. Rather, we have continued to focus on reasonably valued companies with improving fundamentals over our time horizon.

The analysis and opinion expressed in this report are subject to change without notice. They do not represent a buy or sell recommendation and should not be viewed as a promise of future performance. The specific securities identified and described do not represent all of the securities purchased, sold or recommended for advisory clients and it should not be assumed that investments in the securities identified and discussed were or will be profitable now or in the future.

Terms and Conditions ("Terms")
Last updated: June 03, 2015

Please read these Terms and Conditions ("Terms", "Terms and Conditions") carefully before using the http://www.skba.com website (the "Service") operated by SKBA Capital Management LLC ("us", "we", or "our"). Your access to and use of the Service is conditioned upon your acceptance of and compliance with these Terms. These Terms apply to all visitors, users and others who wish to access or use the Service. By accessing or using the Service you agree to be bound by these Terms. If you disagree with any part of the terms then you do not have permission to access the Service.

Copyright notices:
With the exception of images used in this website, which are used under a creative commons license, all content on this website is Copyright 2015 SKBA Capital Management LLC.

Links To Other Web Sites
Our Service may contain links to third party web sites or services that are not owned or controlled by SKBA Capital Management LLC. SKBA Capital Management LLC has no control over, and assumes no responsibility for the content, privacy policies, or practices of any third party web sites or services. We do not warrant the offerings of any of these entities/individuals or their websites. You acknowledge and agree that SKBA Capital Management LLC shall not be responsible or liable, directly or indirectly, for any damage or loss caused or alleged to be caused by or in connection with use of or reliance on any such content, goods or services available on or through any such third party web sites or services. We strongly advise you to read the terms and conditions and privacy policies of any third party web sites or services that you visit.

Governing Law
These Terms shall be governed and construed in accordance with the laws of California, United States, without regard to its conflict of law provisions. Our failure to enforce any right or provision of these Terms will not be considered a waiver of those rights. If any provision of these Terms is held to be invalid or unenforceable by a court, the remaining provisions of these Terms will remain in effect. These Terms constitute the entire agreement between us regarding our Service, and supersede and replace any prior agreements we might have had between us regarding the Service.

Changes
We reserve the right, at our sole discretion, to modify or replace these Terms at any time. If a revision is material we will provide at least 30 days notice prior to any new terms taking effect. What constitutes a material change will be determined at our sole discretion. By continuing to access or use our Service after any revisions become effective, you agree to be bound by the revised terms. If you do not agree to the new terms, you are no longer authorized to use the Service.

Contact Us
If you have any questions about these Terms, please contact us.