The first half of 2017 has been good. The market has continued to move higher, and volatility has been virtually non-existent.
The presidential election was expected to have some effect on the markets, and they reacted positively to the same party being in control of both Congress and the White House. The expectation was that plans on matters such as tax reform, including corporate tax cuts, and spending on the nation’s infrastructure would proceed.
Here we are in July, and it has become clear that things will not go as smoothly or as quickly on those fronts. Yet things remain cautiously bullish. Why is that?
First, the fundamentals still look good: The U.S. economy continues to grow, albeit slowly; global growth has been picking up; and the Fed has been making only small increases in interest rates, which are still low.
Second, political matters both around the world and at home aren’t causing any reactions.
Finally, as the third quarter begins, analysts are forecasting that we will see a healthy rise in second quarter profits as they are reported.
In summary, investors are choosing to focus on fundamentals and on earnings rather than on geopolitical, congressional, or political drama.
How different areas have performed
Information technology and health care did very well the first half. Weak oil prices dragged down energy, and financials also lagged.
Global equities have done well, due to a general acceleration in growth around the world. Some weakening of the dollar has also helped.
U.S. large-cap growth has done well, while small caps have not done as well. One reason for this is that small caps are tied more closely to the domestic economy (growing, but underwhelming) than large caps, which receive a greater share of their business from overseas (where growth has been stronger).
Alternative investments, which are intended to reduce portfolio volatility by not being correlated to the market, have provided minimal returns.
Bond funds did a little bit better than expected in the first half. The price of bonds and interest rates typically have an inverse relationship; as interest rates go up, bond prices typically fall. But investment grade, junk bonds, and municipal bonds all have had decent returns. The reasons for this are varied and beyond the scope of this brief review (but we would be happy to talk with you in more depth if you would like).
It’s been eight years … will there be a ninth?
The silver lining to the slow recovery/expansion is that as measured by real GDP, the economy is about 13 percent larger than it was at its previous peak in late 2007. Between early 2008 and early 2010, 8.7 million jobs were lost, but since then we’ve added almost 17 million. The unemployment rate peaked at 10% in October 2009 but is now 4.4%, and many think it could fall further.
All of this has contributed to a general sense of optimism among both consumers and companies. Interestingly, this can lead to higher market volatility: Higher expectations go hand-in-hand with a higher chance of disappointment.
Add greater uncertainty about economic policy, and there is reason to think that stocks might begin going up and down more than they have so far this year. On the plus side, pullbacks might provide opportunities to invest at lower prices.
What about the R-word?
Recessions are caused by significant imbalances in the market – which inevitably cause problems. In 2008, it was the housing market and the financial system. In 2001, it was the tech bubble. In 1990-91, it was commercial real estate and the savings and loan industry. You get the idea.
The U.S. economy is not facing any particular threat from an imbalance today. Stocks might be somewhat overpriced, but not by enough to cause significant problems in the broader economy.
The potential disruptors are in the policy realm. For example, the Federal Reserve could raise interest rates too quickly, slowing already slow-ish growth, or allow inflation to accelerate, which would mean a tightening in monetary policy not too far down the road.
So in conclusion, the outlook is generally good. Because we take a long-term approach with our strategies, you should be prepared for a wide range of possibilities.
We hope you are enjoying these summer months. As always, please give us a call or email if you have questions or would like to discuss anything in more detail.