“The answer, my friend, is blowin’ in the wind ” Bob Dylan, Blowin’ in the Wind
The smooth sailing investors experienced in 2017 ran afoul of stormy winds and high seas during the first quarter. Equities started off as a continuation of last year’s bullish markets, and bonds were tempered by the Fed’s continuing rate hikes. Concerns about market volatility, policy missteps and rumblings of global trade tensions caused equities to veer off course, reminiscent of the trials of Odysseus when his crew released the Aeolian winds in sight of their Greek home. This allowed bonds to enjoy a small course correction. Here’s a summary table of market results:
“If one does not know to which port one is sailing, no wind is favorable.” Lucius Annaeus Seneca
Many Wall Street pundits were dismayed by the equity markets’ Q1 performance given these strong U.S. economic data, which broadly signal continued growth for the near term:
- The Conference Board Leading Economic Index – was up 0.6 percent in February and is in an uptrend.
- The PMI Composite Index – flash reading for March was 54.3. A level greater than 50 is considered expansionary.
- Stock earnings –for the just-completed Q4 2017 reporting cycle were excellent, with ~75% of companies in the S&P 500 beating both earnings and revenue estimates. Margins improved as well. Estimates for 2018, partly due to the recent tax legislation passed by Congress, are also quite strong.
- The slope of the yield curve – is still positive, meaning that longer-term bonds have higher yields than shorter-term bonds despite the Fed’s interest-rate hike regime. When yields are ‘flat’ or the curve inverts (i.e. short-term bonds yield more than long-term bonds), economic warning lights begin flashing.
- Inflation – is still hovering around the Fed’s target of 2%. Wages are showing some long-awaited signs of growth as well.
- The unemployment rate – is hovering at 4.0% – 4.1%, and the labor participation rate is increasing.
Fears surrounding interest-rate hikes and an unwinding of trades betting on continued low market volatility pushed markets into the red in late January and early February. Further White House policy concerns and angst over the pace of rate increases caused turmoil later in the quarter, leading to a light rebound for bonds and U.S. SMID-cap stocks at the expense of large-cap U.S. and foreign equities:
“No wind serves him who addresses his voyage to no certain port.” Michel de Montaigne
We remain bullish on the economy and stocks generally for a number of reasons: Global and U.S. growth is still expected to be positive; earnings-growth estimates — particularly those in the U.S. — are strong (see below); unemployment is improving in a number of regions; and inflation, while rising, is still not a threat. Investors may also have overlooked the fact that the recent pullbacks have ‘reset’ valuations in equity markets; some segments of the market now look more attractive than just a few months ago.
We’re also pleased to see the markets catching up to the Fed with respect to the level of short-term rates and the number of policy increases for 2018:
“We cannot direct the wind, but we can adjust the sails.” Dolly Parton
Given the data we see, our major concerns are in the following areas:
- Global trade – The Trump Administration is focusing on the U.S. trade deficit and is proceeding with a tariff-increase program that is roiling markets. President Trump is seemingly bypassing conventional protocols for resolving trade disputes with tariffs. There is concern that these new tariffs may harm American industries more than their foreign targets.
- U.S. federal debt and deficits – are expected to increase following the passage of the Tax Cuts and Jobs Act of 2017 and the engorged spending bill agreed to in Congress in early 2018. The effects of the legislation are expected to take some time to work themselves through the U.S. economy.
- Geopolitical concerns – are increasingly worrying. Consolidations of power by Russia’s Putin and China’s Xi are troubling, as is the perpetually unsettled situation in the Middle East. America seems ill-equipped to meet some of the challenges of these situations, as White House policy seems unsettled and we move to our second Secretary of State in just over one year.
Our expectations are that, if the Fed moves to continue normalizing rates (rather than tightening to slow the economy) and some policy clarity in regard to the issues above emerges, the markets will return to the paths that investors expect in a mid-to-late cycle global expansion. Removing some uncertainties from what promise to be strong earnings this year will definitely get bulls snorting again.
As always, we welcome your comments and questions.
—Your Wealth Management Team at JJ Burns & CompanyDownload Market Commentary
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