Waiting for Proof
BY DARREN MUNN, CFA
What a difference a year makes! While 2016 started with a large drop in the equity markets, 2017 started with a continuation of the market gains experienced after the election with very little interruption. Yet, we still have not seen any progress on the tax reform or health care reform, which many (including me) believe are the primary drivers in moving the market higher over the last several months. The healthy skepticism we expressed last quarter remains and time is likely running short for results to happen before the market loses patience.
Based on the data we have seen so far, it doesn’t appear the economy has accelerated like many expected. The Federal Reserve raised rates another .25% in March and expects two more increases this year, but we continue to expect moderate & sluggish economic growth, which will make that third increase very difficult. The market seems to be agreeing with us now as the 10-yr bond yield has dropped quite a bit since the rate increase in March.
To top it off, there have been significant headlines in Europe, China, North Korea, and now Syria – none of which have seemed to faze the market. Corporate profits are expected to be significantly higher for Q1 2017 than a year ago, which seems to be the focus of the markets (rightfully so). Oil has been relatively stable and energy companies are starting to show some profits, which is a significant turnaround from last year.
The S&P 500 and Dow Jones Industrial Average experienced strong returns in the first quarter and bonds experienced some small gains, as 10-year yields moved down slightly for the quarter. But underlying these numbers, the overall market was actually experiencing some turmoil as select parts of the market are actually down for the year. We could probably dust off a commentary from several quarters ago as the positive returns on the S&P 500 are being driven by a small number of very large companies, creating a false perception that everything is rosy.
We are not fooled, nor are we worried. But we are cautious and expect to have some better buying opportunities in the near future, allowing us to deploy some of the dry powder we have accumulated in many of our strategies.
· Employment continued to be steady with the unemployment rate at 4.5% in March. (U.S. DOL)
· Low oil & gas prices continue to save money for consumers, but the savings have been shrinking.
· We believe energy markets have stabilized and are near equilibrium. We expect oil to stay in the $40-$60 range in 2017.
· Housing has continued moderate--but choppy--growth. Low interest rates have helped keep prices affordable. (Barron’s)
· Economic growth continued in the fourth quarter, but dropped to just 2.1% as we expected.
Challenges & Risks
· Economic growth will likely trend in the 2% range in our opinion.
· Interest rates – the Federal Reserve raised interest rates again in March and expects 3-4 increases this year. We believe this is more than the economy can handle and believe it should only raise twice.
· Government regulation is a potential huge drag. Health care costs are continuing to rise significantly & government interference in several areas (finance, education, energy) continue to limit economic growth. Will this improve in 2017?
· China, Europe, North Korea – we expect these three to capture significant headlines in the coming year.
· Oh, let’s add Russia to this list!
While we have certainly enjoyed the positive run in the market these last two quarters, we know the market will experience some volatility at some point. Trying to time that is futile. Instead, we have sold some positions due to high valuations and are sitting on some more conservative holdings to take advantage when the market creates buying opportunities.
We consider ourselves very blessed to serve you and hope your 2017 is off to a great start!
Sources: 1) Bloomberg 2) Barron’s
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