- Troy Frerichs, CFA - Director, Wealth Management & Financial Planning
- Jeff Clark, CFA, CFP® - Manager, Investments & Wealth Management
- Kent Anderson, CFA - Senior Investment Officer
- Andy Finks, CFA - Investment Officer
- Todd Bunton, CFA - Investment Officer
- Chelsie Moore, CFA, CFP® - Investment Officer
- Jonathan Strok, CFA - Investment Analyst
- Rather than allowing headlines to dictate investing strategies, we recommend investors take a disciplined, long-term approach.
- The stock market rally that was sparked post-Election Day extended through Inauguration Day, virtually uninterrupted, until cooling off a bit in March. Investors have been cheerfully anticipating some big reforms out of Washington, but underlying fundamentals have also improved.
- While recent signs continue to point to an improving U.S. economy, we believe those expecting a new paradigm of robust economic growth and extraordinary stock market returns going forward are likely in for disappointment.
Bad News is a Headline, Gradual Improvement is Not
“Is the Stock Market Now On Thin Ice?” – Forbes
“Washington is now officially holding the stock market hostage” – CNBC
“Stocks just hit an ugly streak that hasn’t happened since 2011” – Business Insider
“A popular stock-market ‘black swan’ gauge is at a record” – MarketWatch
“The Stock Market Could Still Blow Up…” – TheStreet
That is just a random sampling of some of the recent headlines from various financial news sources. Given these ominous headlines, investors may be lead to believe that the stock market is either currently crashing, or about to crash. While a correction is always possible, the stock market has actually been remarkably tranquil recently. But that hasn’t stopped media outlets from trying to create fear – and mouse clicks.
In the 1941 cinema classic Citizen Kane, newspaper tycoon Charles Foster Kane declares, “if the headline is big enough, it makes the news big enough.” In today’s world of 24-hour cable news, social media, the blogosphere and blatant “fake news” websites, “big headlines” are ubiquitous. As investors, acting on the vast majority of this prattle can be hazardous to your wealth.
Rather than allowing headlines to dictate your investing strategy, we suggest developing a long-term plan, and sticking to it. As Bill Gates once said, “[h]eadlines, in a way, are what mislead you, because bad news is a headline, and gradual improvement is not." Indeed, gradual improvement is what we continue to see in the U.S. economy, and it is what we expect to see over the long run – with some bumps along the way, of course.
The stock market rally that was sparked post-Election Day extended through Inauguration Day, virtually uninterrupted, until cooling off a bit in March. In fact, from October 12, 2016 (nearly four weeks before the election) through March 20 of this year, the S&P 500 went without a daily loss of at least 1%. That extraordinary 110 trading-day streak marked its longest run since 1995.
Overall, it was a strong first quarter for both international stocks and large cap U.S. equities. Small cap stocks lagged, however, while investment grade bond returns were modest. (Fig. 1).
Indexes Used for Figure 1: Large Cap Stocks – S&P 500 Index, Small Cap Stocks – Russell 2000, Investment Grade Bonds – Citigroup US Broad Investment-Grade Bond Index, International Developed Stocks – MSCI EAFE Index, Emerging Market Stocks - MSCI Emerging Markets Index
Investors have been cheerfully anticipating some big reforms out of Washington since the election, including corporate tax cuts, deregulation, and increased infrastructure spending. But now the question has become: can President Trump deliver? One of his first key initiatives – repealing and replacing Obamacare – failed to pass through the House of Representatives. This defeat has cast doubt on the ability to push through some of the other reforms investors have been anticipating – and largely pricing in to stock prices
However, the stock market rally has not been driven solely by hopes of reform. Underlying fundamentals have generally improved. The labor market continues to show signs of strength, as monthly job growth remains robust and the official unemployment rate sits below 5%. (Figure 2) The Institute for Supply Management’s monthly manufacturing and non-manufacturing indexes are running near multi-years highs, indicating firm expansion in the economy (Figure 3).
Housing prices continue to rebound at a solid pace. Meanwhile, the “earnings recession” of 2015-2016 has ended, with corporate profits expected to accelerate at a healthy clip this year.
Nonetheless, with rising stock prices comes rising expectations by investors for economic growth and earnings. In other words, we will likely need to see continued strong data in order for markets to continue their march upwards. Consumer and business confidence certainly have been soaring in recent months, but we have yet to see this translate into meaningful increases in spending and investment. (Figure 4)
We remain skeptical that the U.S. economy will suddenly achieve a sustainably higher rate of growth. As we wrote in our 2017 market outlook, long-term economic growth is likely to be modest, primarily for two reasons 1) demographic headwinds, which are likely to lead to a slow-growing labor force, and 2) weak productivity gains.
We also continue to believe that the U.S. economy is approaching late cycle, as the recovery that has followed the Great Recession is nearing its 8th birthday. However, we believe that the economy still has room to run, as signs of overheating remain low. Real GDP growth in the fourth quarter of 2016 was a moderate 2.1%, and core inflation, which excludes volatile food and energy prices, has firmed but is not yet running hot. (Figures 5,6)
We do not expect the stock market to remain abnormally calm. Market pullbacks are normal, and we view a correction as a matter of when, not if. Pullbacks are also virtually unpredictable, and we do not advocate trying to dance in and out of the market in an effort to avoid them. Rather, we recommend investors take a disciplined, long-term approach.
Nevertheless, the market no longer has the favorable winds of zero percent interest rates at its back. Although monetary policy remains highly accommodative, directionally the central bank is tightening as it raises interest rates. Investors are now looking to potential fiscal stimulus to boost growth. Whether or not these promises materialize remains uncertain. We also note that fiscal stimulus is no panacea and would favor some sectors more than others.
While extraordinary economic growth may not be on the horizon, the economy finally appears to be strong enough for the Federal Reserve to begin a path to normalizing interest rates. After an initial rate hike in December 2015, the Fed held off on raising the federal funds rate again until the following December amid economic uncertainty. It took them just three months to raise rates again after that.
Based on their current projections, the Fed expects to raise rates two additional times in 2017. Of course, the central bank’s monetary policy is always data dependent, but if the economy continues to improve as expected, then look for short-term rates to continue rising.
Long-term rates have also risen in anticipation of stronger economic growth and perhaps higher inflation expectations. This uptick in rates since the election has been a headwind for the bond market. However, this has been alleviated somewhat by a continued tightening of credit spreads.
We continue to believe that interest rates will remain relatively low compared to their historical averages and that fears of an impending crash in the bond market are overblown. One factor likely to keep a lid on U.S. rates is the extremely low rate environment in developed markets overseas. While the central banks of Europe and Japan have been easing up on their quantitative easing programs a bit, rates still remain exceptionally low there. In fact, the spread between the 10-year U.S. Treasury note and the 10-year German Bund recently hit its widest level in recent history. (Figure 7)
In the battle for eyeballs and mouse clicks, it would be tough for news outlets to compete if they ran headlines like “Violent Crime Down Significantly in Recent Decades“ or “Global Poverty Continues to Fall” (although both are true). In the news business, fear sells. For investors, overreacting to grim headlines should not be part of a long-term investing strategy.
Those who were scared out of the stock market after Election Day in November have missed out on a strong rally. As Warren Buffett stated recently, “[p]robably half the time in my adult life I’ve had a president other than the one I’ve voted for, but that has never taken me out of stocks. If you mix your politics with your investment decisions you’re making a big mistake.”
Whoever occupies the Oval Office is certainly important, but the massive train that is the U.S. economy is neither likely to be derailed nor greatly accelerated by one man. While recent signs continue to point to an improving U.S. economy, we believe those expecting a new paradigm of robust economic growth and extraordinary stock market returns going forward are likely in for disappointment. (Figure 8)
The S&P 500® Index is an unmanaged index that contains securities typically selected by growth managers as being representative of the U.S. stock market. The Index does not reflect investment management fees, brokerage commission and other expenses associated with investing in equity securities. It is not possible to invest directly in an index.
The MSCI EAFE Index is broadly recognized as the pre-eminent benchmark for U.S. investors to measure international equity performance. It comprises the MSCI country indexes capturing large and mid-cap equities across developed markets in Europe, Australasia and the Far East, excluding the U.S. and Canada.
The MSCI Emerging Markets Index captures large and mid-cap representation across 23 emerging market countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000 is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set. The Index does not reflect investment management fees, brokerage commission and other expenses associated with investing in equity securities. It is not possible to invest directly in an index.
The Citigroup US Broad Investment-Grade Bond Index tracks the performance of US Dollar-denominated bonds issued in the US investment-grade bond market. Introduced in 1985, the index includes US Treasury, government sponsored, collateralized, and corporate debt providing a reliable representation of the US investment-grade bond market.
The federal funds rate is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight. The Federal Open Market Committee, which is the primary monetary policymaking body of the Federal Reserve, sets its desired target range.
The Institute for Supply Management’s non-manufacturing index is based on data compiled from purchasing and supply executives nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month. The NMI® (Non-Manufacturing Index) is a composite index based on the diffusion indexes for four of the indicators with equal weights: Business Activity (seasonally adjusted), New Orders (seasonally adjusted), Employment (seasonally adjusted) and Supplier Deliveries. An NMI® above 48.9 percent, over a period of time, indicates that the overall economy, or gross domestic product (GDP), is generally expanding; below 48.9 percent, it is generally declining. The distance from 50 percent or 48.9 percent is indicative of the strength of the expansion or decline.
The Institute for Supply Management’s manufacturing index is based on data compiled from purchasing and supply executives nationwide. Survey responses reflect the change, if any, in the current month compared to the previous month. The PMI® is a composite index based on the diffusion indexes of five of the indexes with equal weights: New Orders (seasonally adjusted), Production (seasonally adjusted), Employment (seasonally adjusted), Supplier Deliveries (seasonally adjusted), and Inventories. A PMI® reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining. A PMI® above 43.3 percent, over a period of time, indicates that the overall economy, or gross domestic product (GDP), is generally expanding; below 43.3 percent, it is generally declining. The distance from 50 percent or 43.3 percent is indicative of the strength of the expansion or decline.
Chart data comes from Thomson Reuters Datastream, a powerful platform that integrates top-down macroeconomic research and bottom-up fundamental analysis
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