Economy and Market Direction

Economy and Market Direction

The economy and financial markets have been improving and stable despite several challenging events globally.  We get few calls when the stock market does well, or even when it just muddles along.  Clients are happy and optimistic when they are making a buck.  Well, it seems that our clients are reflective of people everywhere.  Companies and Universities regularly survey people across the country and then publish their findings.called “Market Sentiment”.  It seems that market sentiment is high during periods when markets are steady, trending upward and volatility is low – like now.   Markets that are not too hot, not too cold, but just right are called Goldilocks periods.

During the last quarter, we enjoyed a continued global recovery in industrial activity, reduced global deflationary pressures, and generally accommodative monetary policy, even though the Fed is raising interest rates.  The markets are trading in a narrow range with low volatility.  There is political uncertainty in both the White House and Congress. Perhaps this high market sentiment is allowing too much good news to be priced into the markets and minimizing the risks of uncertainty. 

Nevertheless, the outlook for the domestic economy is positive.  The global expansion appears to be continuing, interest rates are rising, unemployment is at very low levels, companies are reporting steadily increasing earnings, and inflation has finally achieved the 2% target set by the Fed several years ago,  With this backdrop, it is difficult to forecast a major market decline in the near-term. 

Looking forward, we believe these trends will continue.  However, despite this tranquility, many changes have been taking place over the past few quarters and we have made several changes to our asset allocation models. 

There has been a shift of leadership from small cap stocks to large, from value to growth, from foreign developed-country stocks to domestic, and other shifts including real estate and gold.  We will continue to study these trends and to change our asset class weightings in an effort to reduce risk and enhance future returns.  At the moment, we are comfortable with our current diversification.

Risks ahead include political uncertainty with a new President who has no government experience.   He must learn how to move legislation along with a non-supportive Congress that includes many members of his own party.  He clearly overlooked Republican opposition in the failed bid to change Obamacare.  Future efforts to achieve his campaign goals will include tax legislation for corporations and individuals that will stimulate the economy and still be revenue neutral, and repatriation of corporate tax hordes that could be used to invest in new plants and equipment to generate new revenues and profits.  These goals are large and complex, so their likelihood of success may be deferred to 2018.   

As the U.S. transitions from a mid to a late cycle economy, there is a slowdown in hiring but the economic expansion is starting to hire workers nolonger being counted as part of the unemployed, wages and commodity prices are increasing, and fears of an imminent recession are disappearing. While few are projecting double digit returns on equities, most seem to be satisfied  just muddling along with positive and increasing investment returns.  There is nothing wrong with a feel-good Goldilocks economy. 

Most new jobs involve a period of learning and adjustment.   The complexity and challenges are often different than expectations.  One positive change for President Trump is that he has moderated many of his goals to more well-considered and pragmatic positions.  In recent negotiations with foreign leaders,  he offered to soften import taxes on foreigngoods in exchange for support in Syria and North Korea.  He may be relying on more astute advisors.  The enormity of the job may be changing the man.

The recent military reaction to Syria for using deadly chemical agents against their own citizens was applauded by Democrats and Republicans alike, and generally supported by other countries.  China and Russia were silent but diplomatic communications with both countries seems to be yielding positive results.  

Has he flipflopped on his goals or were several extreme positions merely to appeal to a majority of voters?  Did he really want to replace Fed chair Yellen for keeping interest rates low for so long and thereby weakening the U.S. dollar?  Would a major real estate developer who borrows huge amounts of money advocate higher interest rates?  Would he prefer the bragging rights of a higher dollar at the risk of hurting our exports?  Hardly!  His real beliefs would favor the opposite because they would stimulate the economy. 

As financial advisors, we have the difficult challenge of evaluating the current state of the economy, positioning investments to benefit from future market developments, and helping our clients to make smart decisions.  Our personal preference, opposition or support of our current president is a factor but irrelevant in doing our jobs well.  The future is always difficult to predict but that is our world.  So when the words and actions of our current president are inconsistent, we conclude that their actions reflect their real beliefs.  Clients often find comfort if they think our views mirror theirs, but our actions are solely based on how developments affect the financial markets and not our beliefs in favor or against policies.  The future of health care, tax reform, NATO, the Fed, and relations with China, Russia, Mexico, Israel, and the American economy will be judged by the actions of our President and Congress, among other factors.  We seek to benefit, regardless of our personal views.

So where is the market headed?  Equity prices are at an all time high.  The market hasn’t declined over 20% since 2008.  Does this mean that a major decline is imminent?  What if efforts to stimulate the economy succeed in creating greater future corporate profits so that prices are more historically reasonable?  We believe that market gains since the election have been greater than economically justified but the recent slowdown will give us time to see if future earnings growth will catch up with market gains.  We are cautiously optimistic that this will occur and therefore are fully invested. 

Why we do what we do

While we may or may not agree with our country’s leaders, our mission is narrow, but important – to act as fiduciaries in managing our clients assets to help them achieve financial independence and to help make their futures greater than their pasts.

We will continue to tinker with our models in an ongoing effort to reduce your risk, reduce expenses, and increase returns.  Unlike the former Maytag repairmen, who did nothing because their machines never needed service, we continually strive to get better in a constantly changing world. 

Marv Kaye, J.D., CFP

Kaye Capital Management