Q1 2017 Economic / Market Recap
The “Trump Rally” that started in November after the 2016 Presidential Election has continued in 2017. In the 1st Quarter, the US Dow Jones Industrial average was up 5.19%.i Developed Global Stock Markets (i.e., Europe, Japan, etc.) also had a good performance and were up almost 6%.ii Emerging Markets (i.e., China, India, Brazil, etc.) led the pack, however, and were up over 11%.iii The bulk of the performance occurred in February as both January and March were relatively flat for all global stock markets.
The Bond Market stabilized a bit after a shaky Second Half in 2016. The broad US Bond Market (i.e., US Aggregate Bond Index) was up 0.82% for the 1st Quarter.iv
In addition to the generally positive performance from most asset classes, there was relatively little drama during the 1st Quarter. The worst stretch was the first three weeks of March when the US stock market declined about 3%. Compare that calm to the 1st Quarter of 2016 when markets were down at one point over 11%!v What a difference a year can make.
Q2 2017 Outlook
Why Are Stock Markets Rallying After the Election?
This has been a common point of discussion over the first three months of 2017. Many clients want to know, what changed?
We do feel that it is safe to say that a lot of investors have a higher sense of optimism and confidence now than over the last couple of years. Currently, consumer confidence is at its highest level since December 2000.vi We are not saying that this is completely tied to the outcome of the November elections, but consumer confidence has been on the rise since the 4th Quarter of 2016. Generally speaking, when consumers are confident they buy stuff and are willing to take more risks. Those two trends can lead to higher stock prices and an improving economy.
Granted this is a small sample size, but many of our business clients are suggesting to us that their businesses are doing well and that they are looking for opportunities to expand. To us, this is good confirmation that there is a willingness to spend money, take risks, and to play offense. We take these in total as a positive thing for the economy.
We also feel certain in saying that business people, investors, and consumers are anticipating a Trump White House to deliver on campaign promises of a tax reduction and reduced government regulation. Many investors view these items to be crucial as potential drivers of economic expansion. It is still too early to get a clear reading on what exactly President Trump is going to be able to do—the Framers made our government complicated and hard to make dramatic changes quickly. Certainly, getting much of anything significant through Congress is going to continue to prove to be a challenge. At the end of the day, any President, no matter if they are Republican or Democrat, can only do so much without Congressional support.
Beyond what appears to be confident consumers and a willing Administration is a continuing trend of economic improvement. The US economy has shown signs of acceleration over the last 3-6 months. The 4th Quarter 2016 GDP data was recently revised up from an initial reading of 1.9% to 2.1%.vii Granted this is not at the level that most of us would like or President Trump said is his goal, but those readings are nowhere near contraction levels. We will get the 1st Quarter’s initial estimate in late April. Currently, the Atlanta Federal Reserve is projecting a positive GDP number, albeit a slightly slower pace of expansion than in the 4th Quarter.viii Other economic data (i.e., housing, personal income, orders of goods, etc.) continued a positive trend during the first three months of 2017.
How Long Can This Rally Last? Is a Stock Market Crash Coming?
Obviously, this is always the Million Dollar Question. Anyone that can answer this question with 100% certainty should make a beeline to Vegas!
We do not see a significant stock market crash (i.e., 20%+ decline) occurring anytime soon. We do believe, however, that the stock market is a bit ahead of itself. The recent release of the Federal Reserve minutes suggests some members of the FED share a similar view that current market values are high compared to their historic norms.ix We believe a short term pull back of the stock market of 5% to 10% would be healthy and restore some value. Corrections in this range are normal and typically occur at least once a year. Should a correction of this type develop, we would view it as a buying opportunity. Cash will be our friend if the pullback occurs—both to protect the portfolio in the pullback and to allow us to “buy low”.
Outside of the market pullback described above, our opinion is this rally may still have some legs to run. One of our trusted economists, Bob Brinker, recently stated that the S&P 500 has “…the potential to trade into the 2400s given the fact that stock prices have a historical tendency to overshoot their valuation potential.”x Improvements in the economy such as higher GDP growth could push the market even higher. It will be all eyes on corporate earnings and the economy.
Of course, there are always numerous things to worry about to include geopolitical risks (Syria, Iran, North Korea to name a few), terrorist’s acts, and unseen and previously unknown meltdowns. However, these things are impossible to predict with certainty and we suggest it unwise to design an investment strategy based upon most of these.
Interest Rate Update. Should We Lessen Bond Exposure if Rates Are Going Up?
The well-known fact is that when interest rates rise, the price of most bonds fall. This is not rocket science and has been a common talking point for the TV “financial gurus” for the better part of the last 4-5 years. With the intended path of the Federal Reserve to raise rates several times in 2017, we have fielded questions about “bonds getting killed.”
We would like to offer a little perspective on the potential “bursting of the bond bubble.” In looking back over the last 20 years (1997-2016), the broad bond market has posted two negative years. In 1999 the bond market lost 0.8% because interest rates increased 40%xi. In 2013 the bond market lost 2.0%.xii—interest rates increased 65%.xiii
Said another way, even if bond interest rates doubled in 2017 (that is not expected by the way), we would expect only nominal declines in bond performance. It is also important to remember that a poor bond market is NOT the same as a poor stock market. Bond performance in 2013 was the worst in 20 years with a loss of 2.0%. Everyone remembers the US stock market loss in 2008 of almost 40%. -2% vs -40% isn’t the same!
Furthermore, we have advocated for some time that clients should have bond exposure beyond traditional government bonds. We favor a more flexible, tactical approach to bonds and fixed income securities that offers exposure to corporate bonds, high yield bonds, and international bonds. We have used PIMCO Income (PIMIX) with many of our clients—it has served in this role very well for many years. The fact is, many clients need and benefit from some exposure to bonds and fixed income securities for purposes of diversification, income, and risk reduction.
A lot of how markets will play out in the remainder of 2017 depends upon what President Trump’s administration can get accomplished. Throughout the campaign cycle, he stated that his policies could create better paying jobs, faster economic growth, more secure borders, and lower government spending/regulation. In our view, if he can deliver on some of these policies, then financial markets will continue to advance. As of today, a recession does not threaten the economy. According to most credible economists and market strategists, the economy is moving in the right direction. There are few historic incidents of stock market crashes or Bear Markets without an economic recession. It is this improving economic foundation that provides us with a sense of optimism.
As always, we will continue to monitor market and economic events and advise accordingly. Thank you for your continued trust and confidence!
We hope that you have a wonderful Easter holiday!
vii Wesbury, Brian S. & Stein, Robert. “Real GDP Growth in Q4 was Revised up to a 2.1% Annual Rate.” FT Advisors. March 30, 2017. viii https://www.frbatlanta.org/cqer/research/gdpnow.aspx?panel=1
x Brinker, Bob. “Bob Brinker’s Marketimer.” Volume 32, No. 3. March 4, 2017.