The first quarter of 2017 saw a strong U.S. equity market and a more challenged fixed income market. The S&P 500 finished the quarter with an impressive 5.5% increase from where it started on January 1st. The market increase was driven by two major factors:
- improving corporate profits
- the anticipation that the Trump Administration will be successful in lowering corporate taxes and reducing regulatory burdens on businesses
During the first quarter, there were a number of events that could have derailed the stock market ranging from the transition to a new U.S. President, to political upheaval in South Korea and missile launches in North Korea, to the official start of Great Britain’s exit from the European Union. Yet, these were hardly speed bumps in a generally upward trend.
As we have mentioned in prior commentaries, the current bull market is the second longest on record. We are entering our eighth year without a 20% correction signally a bear market. While this market is impressive from a historic perspective, it does give pause to consider that no market goes up indefinitely and therefore there is a bear market in our future. While we understand the rationale of such sentiment, and in fact agree that every great bull market will ultimately be followed by a correction in the normal fashion of economic cycles, the question is always when that bear market will begin? Some thoughts to help put perspective on this question:
- By a number of standards, the market is either overpriced or as some pundits say, “priced to perfection.”
- Others believe that both expanding corporate profits and the likelihood of lower corporate taxes means that the market has room to grow.
- Glen Eagle falls in the camp that we believe that caution is warranted for the following reasons:
- Markets do not go up continually
- When expectations are not met, there is often a substantial movement down. This is true of companies that miss earnings and is likely to be true if the projected spending, tax cuts and regulatory changes do not materialize in the expected timeframes and/or are smaller than anticipated.
- The Federal Reserve tightens interest rates faster or greater than anticipated. As the price of borrowing increases this acts as a brake on both the economy and the stock market.
- An unforeseen international event, such as a terrorist event or war can spook the market.
- While it may be prudent to increase the amount of cash you are holding with the goal of buying into the market if there is a correction, often late cycle bull markets end with a spike up that you can miss if too much money is on the sidelines. To further highlight this point, JP Morgan did a study in early 2014 that looked at the cost of being out of the market on the largest days of movement in the market over time. They studied the period from 1993 to 2013 (20 years). They found that being out of the market for just the ten best days during that market resulted in an investor’s return being 41% less than someone who remained invested for the whole period (see chart on the next page).
- Consequently, we feel that investors should continue to maintain exposure to the markets, especially the U.S. markets. Rather than time the markets we are focused on overweighting those sectors and individual companies that we feel are best positioned in the current economic environment.
- For example, banks are expected to benefit from decreased regulation and increasing interest rates. The largest banks (those deemed “too big to fail”) have some of the strongest balance sheets they have had in over 50 years and are positioned much better than competitors in Europe.
- Also, at times when traditional valuations are high it is often useful to focus on more value-oriented stocks that show strong fundamentals. While this does not mean that they are risk-free from a market correction, it usually does indicate that they are less risky than companies that are being priced to anticipate substantial growth.
- As interest rates rise, real estate companies (REITS), utilities, and high dividend paying stocks will no longer be as sought after by as many investors because they will be able to find higher yields from bonds and even money market funds. This effect will not be immediate, but will occur over time as the Federal Reserve continues to raise rates.
- Those companies that have a history of increasing dividends will still appeal to investors that are concerned about inflation eating up purchasing power.
- After an extended period of underperformance, we expect that international markets will begin showing more substantial growth. For US investors, however, some of this growth may be offset by the strong dollar.
A Few Other Thoughts
- Unless unemployment starts to creep up, which we see as unlikely at this point, we expect at least two more 25 basis points (1/4 of a percent) rate increases from the Fed this year. Similarly, we expect to see inflation end the year in the 2.5% to 3% range this year.
- Both the growing U.S. economy and the relative difference between our increasing interest rates ant the interest rates of other countries is helping to keep the U.S. dollar strong. While this is a challenge for U.S. exports it might be a good time for a European vacation.
Wishing you a warm and happy Spring!
Susan McGlory Michel
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.