What To Expect From the Markets in Q2

The streak is over. Nine consecutive months of quarterly gains for the S&P 500 index have come to an end as a tumultuous first quarter of 2018 closed. It may be hard for some people to accept this, but it could have been a lot worse. Both the S&P 500 and the DJIA fell into a correction over the past 90 days, but both managed to claw their way out like Leonardo DiCaprio in The Revenant. Looking for reasons for the sell-off and the volatility? There are plenty, and we've heard, read and written a lot of them:

"We've come too far too fast!" "Valuations were too frothy!" "Political instability and unpredictability!" "The Big Money is rotating out." "It's Facebook's fault!' 

It is perhaps not in anyone's interest to try and predict what the markets might be up to in the coming quarter but the things that we do know can help investors brace for what lies ahead:

There have been 20 moves of 1% or greater in the S&P 500 in the last two months. There were only 10 in the previous 12 months. To be sure, 2017 was an exceptionally quiet market -- the calmest in recent history -- but 2018 is acting like a two-year-old being yanked out of a toy store before he's ready to go. This chart, courtesy of Michael Batnick, paints the picture:

Graph courtesy: Michael Batnick, Ritholtz Wealth Management.

Our own Investopedia Anxiety Index, which tracks increased search volume of fear-based terms, is telling us that the anxiety our readers are feeling is about the markets, not the economy or their personal finances. The macro-economic picture is fairly stable. We are growing, albeit moderately.

That said, there were many moments of political chaos that should've slapped the markets around last year, but it continued to grind higher. Investors who booked beautiful gains in 2017 may not be as patient this year. They've already showed signs of their shortened fuse and we have a mid-term election coming in November.

The remarkable growth of ETFs -- like SPDR S&P 500 ETF Trust (SPY), SPDR Dow Jones Industrial Average ETF Trust (DIA) and PowerShares QQQ Trust (QQQ) -- may have lulled some of us to think that these products were for buy-and-hold passive index investors who were happy to tuck them into their 401k or brokerage accounts and go fishing. That's not the case anymore. During the February correction, the normally stable SPY sold off 9% over the course of a few days. That hadn't happened in its 25 years, according to Jim Ross of sponsor State Street Global Advisors. More institutional investors are using ETFs for a variety of purposes, including hedging and overall portfolio smoothing. According to Deutsche Bank, institutions accounted for 57% of ETF ownership as of 2016. Expect that number to increase as the ETF market continues to grow. The notion that exchange-traded products are for passive investors is just not true.

Irrespective of Facebook's (FB) recent issues regarding user privacy and alleged interference by foreign governments, there has been a clear rotation out of technology in recent weeks. The Powershares QQQ ETF has fallen more than 6% since mid March as Facebook, Google (GOOGL), Amazon (AMZN), Netflix (NFLX) and Apple (AAPL) -- its biggest components -- have suffered some weakness. But beyond the Big Five, the sell-off in technology has been widespread and relentless despite their continuing domination of our lives. Given the weight of these companies on the S&P 500 and the Nasdaq, overall market weakness could continue as long as investors shun these stocks.

New FOMC Chair Jerome Powell has basically laid out the pacing of the next few hikes, so don't pretend to be surprised. Higher interest rates affect stock returns, period. Adjust accordingly.

So what's an investor to do? 

Re-balance your portfolio if you haven't already. Take some risk off the table if you feel like you leaned too far into stocks, especially tech. Make sure you have a cash cushion. If you don't have three to six months of savings put away just in case, please start doing that today. Forget 2017. It was an unbelievable year for equity markets and some cryptocurrencies. It was fun and crazy, but it's over.

Winter is over, although it doesn't feel like it in the northeast. The animal spirits are awake and hungry - be aware. There will be fire... stay safe.

Caleb Silver - Editor in Chief