The discordant noise level seems only to increase each day out of Washington, London, Pyongyang, Seoul, Moscow, Tehran, Riyadh, Damascus, Baghdad, Paris, Brasilia etc. Bi-partisan, problem solving governance appears elusive. Media airwaves and print are filled with scandalous stories about “hacking”, election interference, graft, and other intrigue. People are too timid to loudly express their opinions – even on college campuses for fear of being attacked, verbally or physically, by an opposing group. Polite discourse, even if heated, has in too many instances disappeared. This would seem to be an unfriendly environment for investing successfully. But this is not the case. While politics can have a positive or negative influence on the investment environment, it is only an influence within a context of many which create the environment. Politics are a piece of a larger mosaic (including economics, market valuations and other exogenous factors) which investors use to determine prices.
As the above chart well illustrates, stocks in the biggest, most liquid market in the world have not been concerned to date about the “shenanigans” of Washington DC.
Further, while some might be “anxious” after reading a newspaper, bond and stock investors, so far, are quite calm as shown by the above chart.
For the first time since the “Great Recession”, the world is growing in unison. Advanced economies (think US, Eurozone, Japan) are growing in “lockstep” with emerging economies (think China, Vietnam, India). A growing economy is an important ingredient for a successful investment environment.
In support of economic growth, financial conditions have been easy. Central banks around the world have lowered interest rates to historic lows and have enlarged their balance sheets by being active bond buyers. With financial conditions as accommodative as they are, there has never been a recession – nor do we expect one any time in the near future.
Further, the American consumer (70% of the US economy) continues to do his or her “part”. Increasing personal consumption expenditures due to higher employment is bolstering the US economy.
Political “noise” aside, along with economic fundamental support – are markets too complacent and are valuations too high? We’ll only know when we know – i.e. after the fact. But for most investors there are only three broad categories of investment options – cash, bonds and stocks. Thinking back to the last time equities were overvalued (late 1999/early 2000) cash yielded 5% – 6%, 10 year Treasuries paid investors 6.5% and the earnings yield (E/P) on equities was 3.5%. Today, cash pays investors approximately 1%, 10 year Treasuries yield less than 2.2% and the earnings yield on stocks is 4.6%. Alternatives to stocks in 2000 were attractive. Today that is not the case and it is expensive, because of the much lower yield, to “hide” in cash. The same descriptors of the asset classes (i.e. cash and bonds expensive relative to stocks) could be used in most overseas markets – but even more so.
So we would advise readers to “push the noise” aside. Focus on fundamentals. Take an antacid pill if need be. Let the pontificators rant. But do not be swayed from one’s investment discipline by only one piece of the investment environmental mosaic.
PREDICTIONS FOR 2017
- S&P 500 corporate earnings +10% – 15% – Yes – So far earnings better than expected
- Inflation to range from 2.5% – 3% – No – Recent numbers have been lower than expected, but still believe trend is up
- Business investment up due to cuts in corporate tax rates & profits repatriation Yes – Up 2-3% so far this year
- Government spending up due to infrastructure investment. – Yes – To come later this year
- Personal consumption up due to tax cuts & wage gains. – Yes – Consumers are upbeat
- Real GDP growth +3%. – No – Expect improvement later in year
- The Federal Reserve will raise the Fed Funds rate by 0.75%. – Yes – Fed is “on course”
- Bond prices will drop, yields rise (10 year Treasury yield 3.5% – 4.25%). – No – Bond demand remains strong
- The treasury will issue bonds with 40+ year maturities to take advantage of still historically low interest rates. – Yes – Being actively researched by the Treasury
- Equity prices will rise on the back of higher earnings & lower bond prices. – Yes
A FINAL THOUGHT