US Equities Post Strong First Quarter
The Dow broke 20,000 for the first time in history in January, then briefly broke 21,000 during February. We presently sit in the middle. While these numbers don’t tell us anything directly, they do highlight the strength of US markets since the election. Underneath, two primary factors drove market gains: improved corporate profits and optimism surrounding pro-growth government policies.
After experiencing declining profits for seven consecutive quarters, US corporations have delivered two quarters of growth with a third likely on the way. This goes a long way in quelling fears over the economy and valuations. The president’s policies are proposed to benefit profits, as they ease regulations and lower taxes. Recently, due to the GOP’s failure to pass health care reform, markets have become jittery as faith in the administration’s ability to pass legislation has been challenged. While the situation is fluid, we continue to anticipate corporate tax reform to come within the next year (helping 2018) and de-regulation for many industries to persist. These steps should be a tailwind for corporate profits, however, we do not believe they will be a panacea.
We Remain Impressed By Stability Of US Economy Despite The Expansion’s Length
The US economy continues to roll on, despite being 93 months into an expansion versus the 47-month historical average. This is most evident in the healthy labor market. Our unemployment rate recently hit 4.5%, marking the lowest level since the crisis. First quarter saw an average of 178,000 jobs added per month, which is in line with the 182,000 over the prior year. Additionally, jobless claims have been under 300,000 for a record 109 consecutive weeks and sit near all-time lows. Wage growth, a key data point to watch when looking for early signs of a recession, is sitting in the goldilocks zone between 2.5%-3.0%. At this level consumers reap the rewards of more spending power and corporations still enjoy healthy profits due to relatively low wage inflation.
Survey data, or what many call “soft” data, remains very robust. We don’t want to speculate on when the “soft” data will lead to much better “hard” data (US GDP, for example). But what we do know is over time survey data is highly correlated (77% going back to 1970) with real GDP. Given this, we continue to be encouraged by consumer confidence, CEO confidence and small business optimism all sitting near decade-plus highs. We monitor both frequently, and currently the US economy is solid and could be set to improve based on robust survey data, “soft” or not.
Washington Will Be Key Over The Coming Quarters
With US markets moving to new highs during the first quarter, the question remains: where do we go from here? We don’t believe markets are at unreasonable levels (especially versus the bond market), but do take note valuations are more elevated than normal. This fact coupled with the generous gains seen since the 2009 market bottom leads us to believe it’s prudent to lower return expectations over the next several years and adjust portfolios accordingly. There’s also the near-term risk political divide that could delay Trump’s agenda, which has been a catalyst for equities. In fact, rhetoric out of Washington will likely be key to returns over the next several quarters.
The Federal Reserve and its monetary policy have been a key force in driving equity markets over the past several years. But with the Fed raising rates and becoming a risk rather than a tailwind to markets, investors are looking to fiscal policy for economic stimulus. So far, so good. The notion of lower taxes coupled with less government regulation has rewarded stocks following the party change in November. But the low-hanging fruit has been harvested. Talking about legislation is much easier than passing it into law, particularly with the deep political divides in Washington. Lack of healthcare reform is a perfect example of this and has shaken confidence in the pro-growth agenda making its way to law. As mentioned above, we continue to believe many pro-growth policies will take shape as law, but would temper expectations.
Investing over the short-term is a difficult process in the easiest of times, so we can’t say we are overly thrilled with Washington D.C. headlines (speculation mostly and not policy) moving markets on what seems like a daily basis. But, it is what it is and we fully expect this trend to continue over the next several quarters until we get a clearer picture of how the major pillars of Trump’s policy agenda materialize. The goal at CIA is to sort through the noise and stay committed to a diversified portfolio comprised of stocks and bonds that can deliver consistent income and growth over the long-haul.
As always, we’re here to help so please reach out with any questions or concerns as we work our way through 2017.
Regards,
The Investment Committee
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