“Now is the winter of our discontent / Made glorious summer by this sun of York”  Gloucester, Richard III

What a difference a year makes.  Investors started 2016 mired in a brief but sharp correction in all assets.  Beginning in mid-February, equity-related and commodity assets rebounded strongly, partially aided by the election of Donald Trump.  The release of the market’s ‘animal spirits’ spurred the ‘Trump Trade,’ which raised expectations for U.S. growth, inflation, fiscal spending and interest-rate increases.  U.S. financial, industrial and smaller-cap stocks and high-yield bonds did well.

In this 1st quarter, investors cheered as the Trump Trade continued. International equity markets also joined the party, and benefitted from strong data and favorable valuations.  As always, things are not perfect in paradise.  U.S. stocks were flat in March, and commodities and the U.S. dollar have given back some gains as the Trade has lost some steam.  Here’s a summary table of market results:

“We know what we are, but know not what we may be”  Ophelia, Hamlet

Let’s look at the issues we think investors are processing in this new environment:

Global Growth: We see slow but steady progress, with signs that global growth is moving higher in all regions.  This chart on Global PMI, where a reading above 50 is considered expansionary, reflects its highest level since 2011.  Robust expectations and higher implied GDP growth are possible results.  These may promote higher and more diversified commodity prices, inflation, revenues and higher global interest rates, and possibly a flat or weaker U.S. dollar.

The Fed’s interest-rate hikes:  We’re glad that the Fed has begun their hike cycle.  It’s expected to be fairly steady, and it signals that higher inflation and growth are on the horizon.  At the current target policy level, the Fed should be able to react when the next recession strikes.  One point of interest is the market’s expectations for the proposed hikes, which is the difference between the Fed (blue line) and the market (green line) below.  This possibly implies an expected slower pace of hikes, a lower terminal policy level, and lower growth than the Fed is projecting.  Should data exceed Fed expectations for growth or show unemployment rising, the market may have sharp reactions.

Global stock earnings:  Another positive sign is the uptick in regional earnings estimates, which are by nature volatile and subject to frequent revision.  We know prices follow earnings, and much like rate increases, severe shortfalls and / or negative revisions will disappoint investors.  These data reflect one view of current earnings expectations, and may provide some support to market growth:

Expectations and uncertainty:  We’ve written about and discussed on our webcasts the almost surreal geopolitical situation.  The world seems angry at itself, with few solid, progressive leadership relationships driving growth and living standards higher.  Factionalism, despotism and reactionary nationalism are all on the rise; none ever result in positive developments.  The U.S. markets, perhaps buoyed by animal spirits, have moved higher.  Is this a reaction to positive economic data?  A belief in the new administration’s policies?  More irrational exuberance by investors?  Nationalist Geert Wilders’ loss in the Netherlands?  We would posit a combination of all of these reasons.  As this graph shows, the level of policy uncertainty has not promoted nervousness in U.S. markets – yet.

“Some are born great, some achieve greatness, and some have greatness thrust upon them.”  Malvolio, Twelfth Night

We are optimistic about the economy and the markets in the near term.  Investors have been shrugging off steady but historically unremarkable U.S. growth data in the belief that the past will somehow replicate itself in the future.  We also acknowledge that the post-Financial Crisis world is different, but not necessarily worse.  There are clearly many serious issues facing the world’s policy and economic leaders, and the policy uncertainty index referenced above indicates that some of our optimism is shared.  President Trump has proposed an ambitious and complex agenda that includes fiscal stimulus for the U.S. economy.  Other nations are facing many of the same choices as the U.S., and we remain hopeful they will rise to meet them.  The grey cloud in this thinking is the rocky start to Mr. Trump’s administration, and the recognition that the expected policy changes will not be easily outlined or approved.  We expect this cloud to importune other leaders as well.

Our near-term market expectations are for high single-digit returns for stocks and low single-digit returns for bonds, given the data we see.  Our approach to the expected volatility and uncertainty ahead is to ensure that we have the right target exposure to countries, regions and securities, and to be prepared to take advantage of allocation or rebalancing opportunities that present themselves.  Finally, we will review allocations and risk assumptions as we conduct financial-plan and portfolio reviews to keep our clients focused on their long-term goals regardless of the current market environment.

As always, we welcome your comments and questions.

–Your Wealth Management Team at JJ Burns & Company

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