Q2 2018 Review Banner

Led by Small Caps, U.S. Stocks Gain Ground: Q2 Review

Q2 2018 Review Banner

Despite threats of a burgeoning trade war between the U.S. and China, domestic stocks kept rising in this year's second quarter. The blue-chip S&P 500 index produced a total return of 3.43% in the quarter while the Dow Jones Industrial Average ticked up 1.26%. Still, both benchmarks moved into the second half of 2018 below their record highs hit earlier in the year.

Besides announcing tariffs against the world's second-biggest economy, President Donald Trump made plans during Q2 for trade restrictions against the European Union, Canada and Mexico. But entering earnings season (when companies report their financial health for Q2), Wall Street analysts were expecting around 20% growth from S&P 500 constituents compared to the same period a year earlier. That growth rate would be slightly down from Q1, which reached a seven-year high.

Domestic investors turned to small-cap stocks, which on a percentage revenue basis typically conduct more business in the U.S. than internationally. The small-cap Russell 2000 Index returned 7.75% in Q2.

Also worth noting in the quarter, growth-styled stocks continued to outpace value-oriented fare: The S&P 500 Growth Index gained 5.25%, while its cousin value large-cap benchmark rose by 1.40%. The technology focused Nasdaq 100 Index shot up 7.27% in Q2 while the top performing sectors in the S&P 500 were energy and consumer cyclicals, according to Morningstar. 

International markets didn't do as well. The widely followed MSCI EAFE Index of developed foreign stocks slid by -0.97% in Q2. Meanwhile, the MSCI Emerging Markets Index returned -8.83%.

Domestic Equities

Returns for the different size and style of domestic equities differed quite a bit in Q2 of 2018. The returns ranged from 7.00% for small-cap growth equities to 0.37% for large-cap value equities. Meanwhile, stocks as captured in IFA's blended domestic large-cap benchmark jumped by more than 3% as IFA's U.S. large-cap growth index ended up with a positive gain of 5.90%. 

Returns of IFA Domestic Equity Indexes Q2 2018

For the domestic equity indexes used in IFA portfolios, the quarterly return was 4.78% for Q1. This was more than the U.S. market as broadly measured by the Russell 3000 Index, which returned 3.88% in the same time period.

International (Developed) Equities

IFA index returns from developed countries that are outside the United States posted a negative second quarter. In Q2, results ranged from -1.96% for international small-cap equities to -3.47% for international small company value stocks. When looking at the full-year results through Q2, the initial six months of 2018 saw returns ranging from -2.33% (international small caps) to -5.66% (international small-cap value).

Returns of IFA International Equity Indexes Q2 2018

For the blend of international indices used in the IFA Index Portfolios, the return was -2.91% in Q2. This was worse than the MSCI World ex-US All Cap Index, a benchmark of developed international stocks, which delivered a return of -0.83%.

Returns by developed country in Q2 ranged from 5.91% (Israel) to -10.54% (Austria). Top performing countries included Canada (4.26%), Australia (3.98%), Norway (3.46%) and Ireland (2.31%). The worst performing countries included Singapore (-9.71%), Italy (-8.57%) and Belgium (-7.28%).

Emerging Markets

Emerging Markets had the worst quarter of all major IFA equity asset classes. For Q2, EM returns ranged from -9.71% for emerging markets small-cap equities to -9.21% for emerging markets value equities. By comparison, so far in 2018 returns ranged from -8.42% (emerging markets small-cap equities) to -7.17% (emerging markets value equities).

Returns of IFA Emerging Markets Equity Indexes Q2 2018

For the blend of emerging markets indices used in IFA Index Portfolios, the return for Q2 was -9.37%. Our mix underperformed the MSCI Emerging Markets Index, which returned -7.86%.  

Returns by country in Q2 ranged from 4.34% (Qatar) to -26.92% (Turkey). Top performing countries included Colombia (4.27%%), India (-2.57%), China (-4.1%) and Greece (-4.72%). Worst performing countries included Brazil (-26.65%), Hungary (-16.85%) and Thailand (-16.36%).

Real Estate

Global real estate was a picture of the broad benefits of diversification. In the second quarter, international real estate stocks returned -0.38%. But domestic REITs gained 8.68%, providing the IFA Global Real Estate Index with a 5.36% blended return in Q2.

Returns of IFA Real Estate Index Q2 2018

Fixed Income

Interest rates in U.S. income markets increased during Q2, resulting in a change in return for our fixed income positions. In the second quarter, the 30-year U.S. Treasury rate increased by 1 basis point while the five-year U.S. Treasury rate made a positive move of 18 basis points.

For Q2, the four fixed income funds used by IFA delivered returns ranging from 0.55% for Five-Year Global bonds to 0.09% for Short-Term Government bonds.

Returns of IFA Fixed-Income Indexes Q2 2018

For the blend of fixed income used in the IFA Index Portfolios, the return was 0.39% for Q2. This is what we would expect when interest rates have gone up. If interest rates rise, the value of bonds will diminish because investors can get a higher rate of return on newly issued bonds with the same maturity that are currently being offered in the market.

IFA Index Portfolios

The returns of the IFA index portfolios are shown below net of the maximum annual 0.90% advisory fee through June 30, 2018. 

IFA Index Portfolios Returns Q2 2018

What investors need to remember is that there will always be periods in which their IFA Index Portfolios will underperform in the short-term. This is the very nature of taking risk. Given the recent underperformance in U.S. value stocks as compared to domestic growth stocks in both large- and small-cap market sizes, many investors may be wary about their asset allocation.

The chart below shows rolling period returns of the IFA U.S. Small Cap Value Index versus the IFA U.S. Large Cap Growth Index. Over any given month, the odds of U.S. Large Cap Growth stocks outperforming are slightly less than a coin flip. But once we expand our view to longer time horizons, you can see that a disciplined approach yields favorable results for the globally diversified investor.

Each quarter, IFA monitors the funds it recommends for clients, and as part of that process, we've developed a rating system. Here is a link to our Performance Monitoring Report for client portfolios: IFA 2nd Quarter 2018 IFA Client Performance Monitoring Report.

We recently created the IFA Index Funds Investing Kit that includes a copy of Index Funds: A 12-Step Recovery for Active Investors book, the documentary, as well as The Random Walker, which simulates market outcomes based on fair prices right before your very eyes. You can find the investing kit through Amazon.