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Alan McKnight, MBA, CFP®
July 21, 2017
Political stories dominated the headlines during the 2nd quarter, but investors were the beneficiaries of another set of solid gains for the major market indices although the ride was somewhat bumpy. Stocks were strengthened by good corporate earnings, the prospect of possible tax cuts, and strong economic numbers in the foreign markets. This extended gains from the 1st quarter, with the Dow’s YTD change at 8.03% closing at 21,350. The S&P YTD change through 6/30/17 was 8.24% closing at 2,423 while the NASDAQ was up 14.07% closing at 6,140 for the same time period.
This past quarter marked the seventh straight quarter that the Dow and S&P 500 have risen.
In June, the Fed approved its second federal funds rate increase of 2017. Back in March, the Fed raised the rate to between 0.75% and 1%. Currently, as of June’s increase, the new range is 1% to 1.25%. During the June FOMC meeting, it was announced that they will begin the process of reducing their $4.5 trillion balance sheet sometime in 2017; however, their timeline was unspecified. The post-meeting statement noted, "The committee currently expects to begin implementing a balance sheet normalization process this year, provided the economy evolves broadly as anticipated.”
Both the rate increase and the Fed’s upcoming efforts to reduce their balance sheet could produce tighter monetary policy during a time when inflation is lower than expected. However, the economy is continuing to look strong with positive unemployment and housing market data.
Due to demand, the U.S. housing market continues to have a healthy outlook despite big price gains. “Household formation growth over the past year had a notable uptick this quarter over last, playing a big factor in driving up demand for housing and maintaining a strong market,” said David Berson, Nationwide Senior Vice President and Chief Economist. “We are, however, keeping a close eye on affordability and especially house price appreciation as it is well above the long-term average.”
Stocks Keep Moving Up
The day before the Fed meeting, the market experienced a “Fed drift,” the tendency of the markets to rise a few days before their meetings. On June 13, the Dow rose about 90 points, hitting intraday and closing records, closing at 21,328.47. The S&P 500 also had a record close that day, gaining 10.96 points or 0.45% to close at 2,440.
While the markets continue to impress us with records and milestones, it is still prudent for investors to remain vigilant and not get caught up in any of the hype. It is easy to get lost in the headlines that the media presents; however, our job is to remind you that it is best to stay focused on the progress of your own personal goals and plans. While year-to-date, the stock indices have been moving steadily higher and bond rates have drifted lower with limited, if any, volatility, there is always a chance that volatility could turn negative heading into fall.
The Global Markets
Brexit is again at the forefront of potential global financial woes. According to Deloitte, “The rate of chief financial officers who expect some negative, long-term effects from a so-called Brexit climbed to 72% in the 2nd quarter of 2017, from 60% in the 1st quarter.”
Following the United Kingdom’s (U.K.) general election in June, a slowing economy growth of 0.2% (down from 0.7%) in the 4th quarter of 2016, and Brexit negotiations underway in Brussels, many financial executives are increasingly showing lack of faith in the U.K.’s economic stability once it leaves the European Union. While the monetary policy of the U.K. remains in limbo, volatility will remain in the U.K. equity market.
Bonds are still considered expensive in all regions. According to Russell Investments 2017 Global Market Outlook, the U.S. has the closest fair value, while on the opposite end of the spectrum are Germany and the UK. Japan is still on task for their target of zero percent for the 10-year bond yield and the European Central Bank continues with negative rates and asset purchases until at least the end of this year, the report continues.
Additionally, the geopolitical pressures from North Korea and Syria remain potential global concerns that need to be monitored. For now, global concerns have not affected the equity markets, but investors still need to be attentive to global issues.
What about Oil?
A significant increase of U.S. oil production increased the global supply of oil in the first half of 2017. Oil prices continue to stay low, with the price of WTI finding itself steadying between the $44-45/bbl range. With these lower oil prices, U.S. production may begin to slow down. This, along with OPEC attempting to control production levels, may cause oils prices to rebound for the second half of 2017.
"It's going to be difficult to have a rally unless there's a disruption or some news from OPEC," said Olivier Jakob, Managing Director with PetroMatrix. Without any major global conflicts that restrict oil exportation or OPEC inundating the market with excess crude, oil prices should not expect to see major price fluctuations for the remainder of 2017.
For 2017, interest rates will remain high on the market’s watch list. As stated earlier, the Fed raised interest rates by 25 basis points to 1% - 1.25% at their June meeting. This marked the second of three rate hikes that the Fed suggested we could see this year. There is a third rate increase expected before the end of 2017. Interest rates need to be monitored and there is some speculation as to whether or not the Feds will actually decide to increase the rate any more this year.
The Feds announced in June that it will begin the daunting process of reducing its balance sheet that was expanded to help fight the housing crisis that began almost a decade ago. Interest rates are an area that we will continue to watch. Investors should continue to monitor how the bond and equity markets fare with the reduction of Fed stimulus.
As short term interest rates rose, the 10-year Treasury yield fell. On June 15, the 10-year Treasury yield dropped six basis points to 2.15%, which was close to a seven-month low. It eventually moved back up to close at 2.31% for the 2nd quarter.
Interest rate concerns arose when Fed Chair Janet Yellen announced that, “The recent lower reading on inflation has been driven significantly by what appears to be one-off reductions in certain categories of prices,” reflecting the FOMC’s reduction in their forecast for headline inflation down to 1.6% from the 2% target. Yellen herself is not concerned about the weakening inflation trend, stating that it reflects the “progress the economy has made and is expected to make toward maximum employment and price stability assigned to us by law.”
Fidelity Investments feels that “Markets are anticipating the Fed will hike rates only twice through December 2018, instead of the 4 times the Fed projects.” They also say that “historically, the yield curve typically flattens as the Fed hikes rates and the business cycle matures, with inversions occurring prior to each of the last 7 recessions.” Typically, U.S. equity markets have fared well in a rising interest rate environment, but investors still need to pay close attention to interest rate movements.
The 2nd quarter was a healthy one for investors. While the outlook for the remainder of the year still looks positive for equity investors, there are several factors to continue keeping a close eye on.
Geopolitical unrest remains, political gridlock in the U.S., oil prices and further interest rate movements can all be impactful on the U.S. and world investment markets. As always, if you are planning on making any investment changes, it is helpful to discuss these changes and your personal situation with us.
There is some level of skepticism heading into the second half of 2017. “It’s hard to imagine the second half being as good as the first,” says Bill Stone, Global Chief Investment Strategist at PNC Asset Management. Analysts are finding it difficult to believe that the sizeable gains seen in the first half of 2017 can continue. They also suspect that these gains may have taken away from potential gains that might have happened later in the year.
Skeptical sentiment is resonated with comments as Brian Nick’s, Chief Investment Strategist at TIAA Investments, saying, “The market has run as far as it is gonna’ run.” I don’t know about that, but it could be argued that the market has gotten a little ahead of itself since the November 8th presidential election. This is certainly true in the technology sector.
Then there are the optimists. Some Wall Street strategists remain optimistic, expecting the 2017 stock market to repeat its successful first half. Jonathan Golub of RBC Capital Markets, known for being Wall Street’s biggest bull, believes the market will increase 6-7% before the year end.
The fact is, U.S. equities are somewhat overvalued, thus the sentiment that they are susceptible to a swing in the other direction. U.S. Treasuries remain expensive and there are many additional factors that can directly impact the U.S., including:
The Fed’s upcoming balance sheet reduction efforts are worth watching as well, although those efforts, according to San Francisco Fed President John Williams, will be, “widely telegraphed, gradual, and, frankly, boring; and the more public understanding there is, the lesser the risk of market disruption and volatility."
Oppenheimer’s Chief Investment Officer reports that, “heading into the second half of 2017, we believe the elongated U.S. credit and business cycle, currently eight years old and counting, will continue through the end of the year. Yet for the first time in almost a decade, the risks to the global economy are centered in the U.S. and not in other major world economies.” They go on to also report that “growth in much of the rest of the world is stable or accelerating and “in our view, the biggest threat to the global economy is the prospect of the U.S. Fed further tightening U.S. monetary policy.”
What Should Investors be Doing?
For the first half of 2017, stocks have marched higher, bond yields have drifted lower and negative volatility has not been an issue. Investors have not experienced any dramatic up or down swings; however, that does not mean investors should become complacent.
Barron’s reports that, so what if stock markets are up nicely in Asian markets such as India, Hong Kong, and Korea, investors in the U.S. have had a lot to celebrate so far this year. Although the Republican controlled Congress has not yet delivered any sort of tax reform or the financial stimulus it promised, the S&P 500 has delivered 24 record highs. The main question on everyone’s mind is, will the this ride continue through the second half of 2017?
“The market is always vulnerable to a news event, an economic event or an earnings event,” says Robert Sluymer, managing director of technical strategy at FundStrat Global Advisors, a Wall Street research firm.
Guggenheim Global Chief Investment officer Scott Minerd wrote that “stock and bond markets have rarely been more expensive and stable, and that has me worried.” This is an ideal time for investors to be cautious and alert. Many experts feel that a diversified portfolio can help provide some shelter from possible storms. However, with interest rates low, trying to generate high returns while achieving diversification can be difficult.
Today’s fixed rate returns will not help most investors reach their financial goals, so they probably will need to include equities in portfolios. We always carefully monitor the equity markets and interest rates so we can communicate with clients. Market volatility is a part of investing and, instead of being worried by volatility, try to be ready.
It is always best to focus on your personal goals and objectives and not of those of your friends, colleagues, and family members. During times that call for caution, it is always wise to create realistic time horizons and return expectations for your own personal situation and to adjust your investments accordingly. We always try to know our clients’ personal circumstances so we can categorize investments into near-term, short-term and long-term.
Investors should always be prepared. While the market is currently strong, potential volatility should only concern you but not make you panic. Market downturns do happen and so do recoveries; that is simply part of the investing process. This is the ideal time to ensure that you fully understand your time horizons, goals and risk tolerances. Looking at your entire picture can be a helpful exercise in determining your strategy. We always welcome the opportunity to discuss any updates to your thoughts or situation.
If it has been more than a year since your last financial review, please give Jan Berkholtz a call at our office to schedule an appointment so we can make sure everything is in order. If you feel the need to discuss your situation before our next scheduled review, please call our office at (770) 951-9001 or e-mail Jan at firstname.lastname@example.org.
Alan McKnight, MBA, CFP® is Vice President of Kays Financial Advisory Corporation. He has over 20 years of experience working with retirees and pre-retirees. He also serves as an Adjunct Faculty Member and Professor of Finance. Currently he is a doctoral candidate at the University of Florida and is currently conducting research in the area of stock mispricing anomalies caused by intangibles such as customer satisfaction. His research interests also include Investments, Securities Analysis, Behavioral Finance, Asset Allocation, and Risk Management. He can be reached at (770) 951-9001 or at email@example.com.
This report and Mr. McKnight’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any company and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned herein.
Sources: WSJ.com, CNBC.com, Nationwide.com, Oppenheimerfunds.com, Midyear 2017 Outlook , JPMorgan.com, Marketwatch.com, USAToday.com, Forbes.com; APFA, Forefield/Broadridge Investor Communications, Morningstar.com.