What comes easy won’t last, and what lasts won’t come easy.” - Unknown
The strong first quarter of 2017 was the third in a row for stock markets. It might even be one of the most idyllic in decades. Not only was the S&P 500 up 5.5%, its daily price volatility was the lowest since the mid 1960’s, a remarkably smooth ride. The best performing sectors were Information-Technology (Facebook, Apple, etc.), Healthcare (Allergan, Biotech, etc.), and Consumer-Discretionary (Amazon, Carnival Corp, etc.). Energy was the worst performing sector, giving some gains back after leading the markets in 2016. International markets, both developed and developing, bested the S&P, an irregular occurrence over the past eight years. Bonds were largely flat. That’s the rough sketch of Q1. To color in this sketch requires discussing two coincident factors: one is the economy; the other is Trump and the Republican agenda.
Beginning with the economy, GDP picked up in the third quarter of last year providing hope that the trend of below-average growth since the financial crisis improves. Several more recent indications reinforce those prospects. One is that inflation topped the Fed’s target in February for the first time in five years. It appears that that wages are picking up, meaning employers must offer more to attract employees. And that excess capacity is abating, meaning further production increases will require investment. Another is that consumer confidence reached a seventeen year high in February. And third, while this is not a new development, energy prices and interest rates remain low. These are encouraging signs for the economy and for investors. But they are not the only reason for encouragement. The other reason is the potential for pro-growth reform in Washington.
President Trump campaigned on a pro-growth economic agenda and he has the good fortune of his party controlling both houses of congress. Investors have given the President’s agenda the benefit of the doubt as the prospects of corporate tax reform and regulatory relief have inflated animal spirits, which has undoubtedly contributed to the market’s rally. Improving business confidence has been a missing element in the economic recovery since the financial crisis. It may not make much sense to statisticians. But sometimes a spark of confidence can ignite a virtuous cycle of investment, hiring, and growth. Yet confidence is also “easy come, easy go”. As the healthcare effort demonstrates, success is not assured. If the promised pro-growth reforms fail to materialize then it’s reasonable to expect a market pullback as those animal spirits deflate.
For the most part politics is a noisy distraction for the capital markets. The economy is by far the most important factor. From an investor’s perspective any political agenda is only relevant insofar as it influences the economy. Because the economy seems to be catching a tailwind with a potential boost from reform it is my view that stock-market investors should remain optimistic. At this time there’s no clear reason to expect a recession. However, markets are also near all-time highs, which provides us with a good opportunity to make sure we’ve got enough in cash or conservative investments to cover any short-term needs. We can’t know if tax reform will succeed or fail. Therefore the only thing to do is stay invested; to do otherwise would gambling on an unknowable event. Put another way, we have to be in the market to reap any benefits if reform succeeds. But we should also be prepared if it fails.
Brennan R. Redmond, CFA - Senior Vice President
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.)