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“Ain’t No Cure for the Summertime Blues”
“I'm gonna raise a fuss, I'm gonna raise a holler
About a-workin' all summer just to try to earn a dollar
Every time I call my baby, try to get a date
My boss says, ‘No dice son, you gotta work late’
Sometimes I wonder what I'm a-gonna do
But there ain't no cure for the summertime blues” (“Summertime Blues”, by Eddie Cochran)
It is stinking hot and steamy on the East Coast these days, as the proverbial “dog days of summer” set in. Historically, this was a time of year when things slowed down, people went on vacation, and it was generally too hot to move fast, but not this year. The Trump administration keeps bungling its agenda and can’t / won’t move on from the “nothing to see here, folks, but let’s keep looking” Russia imbroglio. The market shrugs off signs of decelerating economic growth and inflation and just keeps hitting new highs. P/E ratios keep expanding as stock price growth outpaces earnings and economic growth.
We are at valuation levels that have been exceeded only 3-4 times in history (all of which were followed by catastrophic market downturns), and no one seems to care. While we are not hearing the clichéd “this time it’s different” sonata, investors are behaving as if, somehow, this time it’s different.
Partly this is due to respectable earnings growth and a low interest (discount) rate environment – companies actually are doing better and the global economy is, in fact, improving (albeit slowly). Partly it is also due to the “TINA” (“There Is No Alternative”) effect – rates are low and credit spreads are tight and, if anything, the public fixed income market looks even more expensive than the stock market (and that’s saying something). Anyone hoping for any level of return needs to invest in stocks.
Market complacency is the order of the day – volatility is trading routinely below 10%, and we have not had a 5% correction in over a year – the longest rally streak since 1995. But, as economist Herbert Stein noted, “If something cannot go on forever, it will stop”.
Put differently, this market will correct – valuations simply are too high for it not to. The economy is chugging along, earnings are solid (although expected to stabilize), and interest rates are likely to remain “lower for longer”. So the market may continue to rise, for a while. But as it begins to price in slower growth, as the Trump agenda stalls, we think the summertime blues may be followed by a winter of our discontent – we will be (gladly) surprised if volatility does not increase and the market does not correct as summer vacations end and we head into Q4 of this year.
Enjoy the beach, lake, mountain, or your own backyard. Catch up on your reading and with your family. This coming fall, we are likely to see more than just a change in the weather.
With that as a backdrop, looking out over the current economic and investment landscapes, here is what we see.
The Current Economic & Market Landscape
- The global economy remains relatively benign right now:
- US Q1 2017 GDP was revised up slightly to 1.4%; the initial estimate for Q2 is 2.7% (which is likely to fall with future estimates); and the estimate for all of 2017 is 2.3% (source: The Wall Street Journal);
- Inflation is decelerating – causing some Fed concern;
- Wages continue to grow slower than employment levels – the tangible consequence of automation and globalization;
- The Eurozone Q1 2017 GDP growth is estimated at 0.6%; and roughly 2.0% for all of 2017 (source: TradingEconomics) – it is gaining momentum, especially manufacturing; on the flip side, as in the US, inflation seems to be decelerating, which will cause anxiety regarding policy maneuvers by the ECB;
- GDP and manufacturing are expanding slowly across most countries;
- There are growing concerns over a “hard” “Brexit”;
- Unemployment is falling overall, but it varies widely from country to country;
- Japan’s GDP was a positive 0.3% in Q1, the fifth straight quarter of positive growth. After weakening dramatically post-election, the yen has strengthened again over the past 2-3 months, hurting exports;
- China’s (official) growth rate is stable at roughly 6.9%, but debt build up, real estate prices, and capital flow controls suggest some underlying fragility;
- The US Fed raised rates again in June and continues to suggest at least one more rate hike in 2017. In her recent FOMC testimony, Fed Chairwoman Janet Yellen suggested that rates will continue to rise and the Fed will begin to “normalize” (run off) its massive bond portfolio. But many viewed the overall testimony as “dovish”. The Fed’s narrative seems to have shifted from trying to get ahead of potential inflation (since inflation is falling) and toward providing the Fed with “room” for a policy response should the economy fall back into recession. While recession does not seem likely, the flattening yield curve suggests the market anticipates slower growth and inflation going forward;
- President’s Trump’s pro-growth economic agenda is on the ropes as health care reform seems to have failed; Democrats remain unshakeable in their universal resistance and opposition, and Republicans begin to pull away from Trump as his approval ratings tank. We continue with our view that any tax, trade, or infrastructure legislation will pass only much later this year, if not well into 2018, when the mid-term elections will move the forefront. Trump’s vaunted negotiating and “deal” skills are not translating into legislative victories in the swamps of Washington DC internecine politics.
The Dynasty Economic & Market Outlook:
The global economy is growing slowly. The primary risks to continued growth are increasing divergence in global central bank policy, the stalling of Trump’s agenda, and decelerating global inflation.
Trump’s hard core base remains loyal, but other Republicans will separate themselves if his approval ratings do not improve – which will put any enactment of a pro-growth agenda significantly at risk.
On the investment side we maintain our general market forecast:
- The global macro-economic environment remains fairly benign but is showing signs (in the US) of slowing;
- Global inflation is decelerating – this creates uncertainty regarding central bank policies;
- The US is attempting to “normalize” rates; the Bank of England and European Central Bank are considering backing off QE; but the Bank of Japan will remain accommodative – creating policy divergence with US;
- The Trump agenda is stalled – investors will eventually price slower growth into the markets;
- Despite solid earnings and low rates, equities still look very expensive to us as price growth outpaces earnings and GDP growth, but we remain modestly constructive for the year, with EAFE and EM markets continuing to outperform the US. The US dollar trend is the wild card for US investors (continued weakening will help non-US returns);
- We continue to anticipate a better year for active managers;
- The US yield curve flattens as short-term rates rise but long-term rates slide as a result of decelerating inflation and expected lower growth. We do not anticipate the yield curve to invert;
- At these rates and credit spreads, the public credit markets look very expensive to us;
- We think there are better opportunities in the private equity and private credit spaces for investors who can access them;
- It is shaping up to be a better year for alternative investments, but we are more optimistic about hedge funds than liquid alternatives because of less liquidity and leverage constraints;
- With oil prices remaining low and global growth perhaps slowing, we now anticipate a very marginal year for commodities and real assets;
- While we are generally constructive on the global economy and overall market performance, the public markets are not cheap and we still expect mid-single digit performance for globally diversified portfolios. Clients need to have their expectations managed as to what a diversified portfolio can deliver.
Summer is upon us, but more than half-way through. The market is calm, humidity is high, and the basil, cucumbers, peppers, and tomatoes in our garden are booming. It’s a good time to relax – but not for much longer. We anticipate some rough seas ahead.
Scott Welch, CIMA®
Chief Investment Officer
Dynasty Financial Partners
Past performance shown is model performance shown is no guarantee of future results. The model portfolio performance does not reflect actual trading or any advisory, management, or transaction fees, all of which could result in substantially lower results. This does not reflect the impact that material economic and market factors have had on decision making. You cannot invest directly in an index.
Source: Bloomberg, Data Analysis, 1/2016-Present
Source: Zephyr, Data Analysis, 1/2016 – Present
Source: Morningstar, Data Analysis, 1/2016 – Present
© Dynasty Financial Partners
© Dynasty Financial Partners
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