As of Oct 19th, the Dow Jones hit its 66th high since the Nov 2016 election. The market has been in a mode of complacent growth with historically low volatility. The number one question I get asked is how high can the market rise? Obviously, no one has a crystal ball that predicts the future. At Glen Eagle our Investment Committee does meet regularly to review the trends based on both qualitative and quantitative data to help steer our efforts to best position our clients’ portfolios for what we believe are the most likely possibilities. Interestingly, in general the data, ranging from unemployment rates to yield spreads, does not imply that the market is overvalued. Most importantly, corporations are generally seeing increasing earnings. There is also no indication of an imminent economic recession.
While the data is not signaling concerns, we do feel that it is prudent for investors to begin to become more conservative by both focusing on downside protection and increasing their exposure to fixed income, preferred stock and convertible instruments. Unfortunately, market turns are often only seen after they happen and while it is likely that in the late stages of a bull market one gives up some return for becoming more conservative, we think it is worth protecting some of your assets from a potential significant stock market correction.
At this point in the market we are closely watching three areas: Tax Reform, the Federal Reserve and International Markets.
The United States currently has the highest corporate tax rate among advanced economic countries. Both the President and many in Congress are actively pursuing tax reform including significant changes to the corporate tax rates. This is an issue that business owners care about, as 52% of small and medium size businesses believe that tax changes will impact their operations more than any other issue. The likelihood of a corporate tax cut is one issue that has been driving the market. Failure to pass a tax cut could be the catalyst for a correction. On the other hand, if there are real cuts to the corporate tax rates it is likely to drive the market higher as this will result in a direct benefit to most corporations’ bottom lines.
One area that both parties in Congress seem to support is the idea of creating a tax incentive for corporations holding cash overseas to bring that cash back into the U.S. If this idea becomes reality the largest technology and health-care companies should benefit. Even without tax reform, we believe that the technology and healthcare sectors will continue to grow as a result of continued automation and an aging demographic, respectively.
The Federal Reserve has indicated that it plans to continue raising interest rates going forward. It is likely that these increases will be relatively slow because the Fed does not want to repeat the mistake it made in the past when it raised rates too quickly and pushed the economy into a recession. Additionally, the recent string of natural disasters in the form of Hurricanes Harvey and Irma may lead the Fed to further slow the hikes as the economies and populaces of Florida, Texas, and Puerto Rico recover. Further complicating the outlook is the fact that President Trump needs to decide whether he will keep or replace the current Federal Reserve Chairwoman, Janet Yellen, at the end of her term in four months.
As we have mentioned in previous commentaries, the rise in interest rates most directly benefits financial institutions, such as banks, that are able to earn more fees from the spread between what they pay for money (deposits) and what they earn on loans.As a side note, we also see some interesting opportunities in materials and construction, companies that will be at the forefront of the hurricane disaster-relief and rebuilding efforts.
The economic expansion has officially taken hold internationally as 98% of the world’s economies are now participating in the growth. Asia and Europe, in particular, look to have some positive momentum. We expect this trend in the larger East Asian economies to continue as corporate earnings rise further and the uncertainty of China’s 19th National Congress, which is planned for the end of October, passes. Similarly, Europe has benefited from the election of pro-European Union (EU) leaders, such as President Emmanuel Macron in France and Chancellor Angela Merkel in Germany. Although there seems to always be another unanticipated cause of fear in the European Union, such as Catalonia’s current independence effort in Spain, we believe that the European economic zone is poised well to continue to grow.
Due to the United States’ stronger economic growth trajectory after the 2008 recession, many portfolios have become heavily weighted toward U.S. investments. While we generally advocated an overweight position in the US market, we think that some allocation toward international markets is beneficial. In particular, materials and semiconductor companies stand to benefit as China’s economy continues to grow. This is because China consumes over 50% of some of the world’s raw materials such as aluminum and concrete, while at the same time having the largest demand for semiconductors as it continues relying on a manufacturing-based economy.
When people are complacent it is always prudent to stay vigilant. If you have any concerns or would like to review your portfolio in detail, please do not hesitate to reach out to us.
I hope you have a great fall season with family and friends,
Susan McGlory Michel
CEO & Founder
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.