Monthly Markets Memo - April 2017
by Dan Zalipski & Scott Rosenquist, CFA
The U.S. Equity markets had a good start to the year adding to the post-election rally. Much of the performance was attributed to an improving economy and the potential of regulatory and tax reforms contained within the new administration’s agenda. More recently however, the U.S. equity markets have hit the pause button, seemingly taking a breather while assessing the feasibility of these reforms.
The S&P 500 only added 0.12% through the end of March, which brings its first quarter return to 6.07%. Markets continue to perform well outside of the U.S. as confidence and economic outlook have been improving, including both developed and emerging markets. Developed international (MSCI EAFE Index) has returned 7.23% in the first quarter, while emerging markets (MSCI EM Index) returned 11.31%. Fixed Income continues to face pressure as interest rates resume their upward trajectory, with the Fed increasing rates at their March meeting. One of the most popular Fixed Income Index, the Barclays Aggregate Bond Index, returned -0.05% for March, bringing the 1st quarter total return to 0.82%. Finally, commodities also remain volatile with the Bloomberg Commodity Index returning -2.33% for the quarter.
The bull market celebrated its 8th birthday this past quarter making it the 2nd longest bull market since World War II. After reaching that milestone, many wonder how much longer it will last with the underlying concern that the next recession could be right around the corner. There’s a popular saying in the industry: Bull markets do not die of old age, they die with excess. The most common culprits include overspending, over borrowing, and overconfidence. For now, the current elevated level of consumer confidence has not translated into excessive spending or borrowing. Household net worth is well above pre-crisis levels, and the percentage of disposable income being used to pay down debt is at its lowest point since the 1980’s. When you consider this along with the low jobless claims and falling unemployment rate, it is reasonable to conclude that the U.S. economy is doing well. While we don’t believe a recession is imminent, it’s prudent to expect bouts of volatility and pullbacks along the way.
Putting the consumer aside, J.P. Morgan has an analysis that focuses on the four most common traits of the broad macro environment that coincides with the end of bull markets: recession, a spike in commodity prices, an aggressive Federal Reserve, or extreme valuations. The St. Louis Federal Reserve publishes its own probability of a U.S. recession based on a proprietary model using economic inputs such as employment and manufacturing. A current reading of 1.36% indicates a low probability of recession. Next, commodity prices are far from spiking with most remaining well below their multi-year highs. Moving on, the Fed has increased rates 3 times in the past 16 months. To put this in perspective, the last rate hike cycle in 2004-2006 lasted 24 months and had 17 rate increases. In fact, stretching back to the 1980’s, the previous 5 periods of rising rates had an average of 9 hikes over a 14-month period. Therefore, as it stands now, 3 rate increases in 16 months is far from aggressive. Finally, despite valuations being above their long-term average, they are far from levels we would classify as extreme. While stocks are more expensive than previous years, they are not nearly as expensive as they were in early 2000 when the S&P forward P/E ratio was 27 compared to 17.5 as of the end of the first quarter. Higher than average equity valuations can persist, especially in an environment where other asset classes struggle to compete.
While interest rates have moved up in the past year and a half, they are still low historically making cash or cash like instruments (savings account, CDs) unattractive for long term investors. Government and investment grade bond yields are also low from a historical perspective making them unattractive relative to equities. Fixed income assets have their place in a diversified portfolio but for longer term goals, equities remain our preferred asset class. This comes with the increased volatility associated with equities, which requires a long term perspective. The backdrop of a strong labor market, growing global economy and some prospect of tax reform in the U.S. should provide support for the equity market moving through the year.
"The fishermen know that the sea is dangerous and the storm terrible, but they have never found these dangers sufficient reason for remaining ashore."
Vincent van Gogh
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to nor does it represent or reflect transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.