February was a good month for investors as all the equity indices we track producing positive returns for the month. The bond market, represented by the Barclays Aggregate Bond Index, also produced a positive return. Commodities are the laggard so far in 2017, losing a little less than 1.00% for the year. The U.S. Dollar index was slightly negative.
|U.S. & International Stock Index Returns|
|S&P 400 (Midcap)||2.54%||4.14%|
|S&P 600 (Small Cap)||1.47%||1.02%|
|Barclays Agg. Bond||0.85%|
|CRB Commodity Index||(0.98%)|
|U.S. Dollar Index||(0.35%)|
Source: Morning Outlook March 1, 2017
Equities continued their post-election run during the month of February with substantial gains for both U.S. and global stocks. The one area that has lagged behind – if one can call a monthly increase of 1.47% underperformance – is small cap U.S. equities. This, we believe, has more to do with the outperformance small companies had in 2016 than a fundamental issue with the asset class. After strong periods of performance it is natural for an asset to “correct” or “rest” for a period of time.
After years of underperformance global equities are starting to perform well. Developed markets like European and Japanese markets have been strong in 2017. Are their economies great or even good for that matter? Not really. Europe is still shaky at best, teetering on the edge of something bad at worst. Japan, on the other hand, does not look like it has broken from its economic malaise that is now in its third decade.
If you have been reading is for some time now you know that stock markets are leading and not lagging indicators. Equity markets turn around before the economic background is attractive, moving in anticipation of better times. You get the reversal, along with good equity returns when the markets perceive things going from bad to less bad. Is the market always correct? No. That said, when the market talks it is wise to listen.
Bond yields for the 10-year Treasury dropped for the month which led to the Barclays Aggregate Bond Index to end the month up 0.85% for the year. From a larger perspective this move is well within the current yield consolidation for bonds. Looking beyond these core bond arenas, corporate bonds have started the year out on a very positive note. The Barclays US Corporate Index is up 1.46% while the Barclays Triple-B-Rated index is up 1.7%. In an investing environment where investors are clearly willing to take on equity risk it is no surprise that they are willing to take on some additional credit risk as well.
After the November elections the U.S. dollar broke above a 20+ month period of price consolidation. It is our belief that the move was a reaction to the election results, with the expectation that the U.S. economy would strengthen due to the fiscal stimulus policies proposed by president-elect Donald Trump. This initial reaction appears to be tempered with the index continuing to hover just above the old resistance level around 100. For the economy, corporate earnings, and trade this is a positive.
For the time being we expect the dollar to continue to stay around current levels. What concerns us going forward is the shape of policy coming out of Washington. With talk of big stimulus (infrastructure) and a new tax structure with lower rates for corporations (and possible boarder tax) a big move in the dollar is a real possibility later this year. Until there is clarity on these issues it continues to be status quo for the dollar.
Once again there is nothing much to see here – consolidation continues.
Last month we noted that times are good for investors. Nothing that has happened in the past 28 days changes that opinion. The economy keeps moving along at a steady pace, interest rates remain historically low, and the equity markets continue to hit new highs on a regular basis. In reality, it doesn’t get much better than this. As CNBC senior contributor Larry Kudlow might put it, right now we are in a goldilocks environment (not too hot, not too cold, but just right).
Here’s the thing about goldilocks investment environments – they don’t last forever. We know that the Governors of the Federal Reserve Bank (“The Fed”) have a stated intention to increase short-term interest rates three times in 2017, followed by another three in 2018. Steady economic growth and creeping inflation leads us to believe a rising interest environment is the new normal. History tells us that both the stock market and bond market can continue to do well at the beginning of a tightening cycle. History also tells us to keep a close eye on this issue as it will have negative market consequences in the future.
Speaking of future consequences, the political environment hasn’t changed. The uncertainty associated with the expected changes to healthcare, taxes and government spending have not gone away. They won’t go away. At some point this year each of the issues will get resolved by either seeing change or a continuation of the status quo. All of these issues are much more complicated than they appear on the surface, and all are surely set for a political showdown of some sort. It may be Democrats fighting Republicans. But don’t be surprised to see so in house fighting amongst the party in charge. Right now none of this is an issue. But at some point the markets may decide it is.
In the short-term the stock market looks and feels to be overbought. While we are not negative on equities we will not be surprised to see the market take a rest during the month of March. Experience tells us that markets don’t go up (or down) in a straight line. The short-term correction we expect could be either a small move down or a simple sideways move.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
Jeffrey T. Bogert, Partner
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