The second quarter of 2017 greeted the S&P 500 with a new milestone: The second longest bull market in American history ever! The upswing from the Great Recession lows has now surpassed the post-World War II streak from 1949 to 1956. In terms of calendar days, the current bull market sits around 2,700 days, safely behind the longest bull of 4,494 days that lasted from 1987 to the year 2000. Due to a resurgence of worldwide economic growth, positive corporate and economic fundamentals, and the ability to tactically rotate investments to our top rated stocks and sectors, we remain optimistic in our investment outlook.
A noteworthy trend has been global synchronized earnings growth. This means that for the first time since 2010, earnings growth is set to rise simultaneously across Europe, the US, the UK, Japan, and Emerging Markets. According to the International Monetary Fund’s latest outlook, global growth for 2017 is expected to touch 3.5%, which is higher than 2016’s 3.1% growth. Additionally, reports have showed that the world’s second largest economy, China, grew by 6.9% in Q1, which marks the fastest rate of growth in a year and a half. The boost was led by higher government infrastructure spending and a renewed property boom that helped raise industrial output growth to a two year high. Over in Europe, after years of regional difficulties, accommodative monetary policy, euro depreciation, and global economic policy have started to positively impact European earnings and valuations. A continuance of strong expansion in Europe would surely assist market growth domestically as well. Also reassuring is the data that shows global trade growth set for its highest pace in a decade. This can have a meaningful impact on corporate revenue growth and, as a result, drives earnings and stock price performance.
Confidence in the US economy was patently displayed on June 14, with the central bank’s decision to increase the target range of the Fed funds rate to 1-1.25%, its second hike for the year. A Fed statement reasoned that “job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined.” With unemployment down to 4.3%, discouraged workers are re-entering the labor force. Even the underemployment rate, the broadest measure of unemployment, declined to 8.6%, its lowest figure in almost a decade. What this means is that both economic and corporate fundamentals are way too healthy to warrant an economy-wide downturn, at least for the near-term while the global economy is not in or around recession. To a large degree, the outlook for equities will depend on earnings, and earnings prospects currently look good. The Thompson Reuters-reported consensus is expecting at least a 10% year-over-year increase in earnings for 2017. While many investors have valuation concerns, it appears that valuations can be sustained or rise further, as long as corporate profits and earnings continue to climb.
From a fiscal policy standpoint, it may seem disappointing at first glance that we have yet to see any stimulus. However, this comes with a silver lining: We are unlikely to see the significant and sharp advance in interest rates or in the US dollar that would probably result from such a package. The lost opportunity on the political front might therefore have the ironic effect of prolonging the bull market in stocks. In fact, the recent weakening of the US dollar is potentially an added tailwind to US manufacturing exporters. In the meantime, an intriguing proposal on the table is a tax holiday for repatriating profits that US corporations have stashed abroad. Furthermore, at an executive level, it does appear that the regulatory environment is getting less burdensome, which should help boost profitability.
For our investment portfolios, a significant portion of holdings continue to be focused on large-cap stocks that are trending higher with the momentum of the economy, specifically those that are included in the technology, healthcare, and financial sectors. The technology sector has the highest earnings growth forecast in 2017, outside of energy and materials with low 2016 comparables, and we continue to see technology leaders increasingly disrupt traditional business models. The tightening workforce provides another tailwind, as employers progressively invest more in technology to accomplish greater productivity and efficiency. Within healthcare, despite some domestic regulatory uncertainty, it is clear that there is a long runway of increasing demand for products and services, both in the US and abroad. Coupled with healthy balance sheets and reasonable valuations, there are pockets of opportunity within the sector. The biggest recent news regarding the financial sector occurred on June 28, when the 34 top US banks all cleared both stages of the Federal Reserve’s annual stress tests, in a clear sign that balance sheets have been shored up across the financial system since the 2008 crisis. Collectively, the six largest banks immediately received permission to announce stock buybacks totaling a staggering $100 billion. The combination of rising rates, a rally in the 10-year Treasury, strong loan demand, and shareholder friendly dividend hikes and stock buybacks, all inspire confidence and could offer price support for the sector.
We would be remiss if we did not mention the lack of volatility in the markets. For the first half of the year, the average absolute daily price change, meaning all negative signs are removed, was just 0.32%. If the year ended there, it would be the smallest daily price change since 1965! It is difficult to fathom such a wide gap between daily political volatility and daily stock market volatility. Just another reason why political attitudes are ill-suited to dictate investment decisions. While low in volatility, the market has also been exceptionally resilient. According to Strategas Research it has been over 280 days since the last 5% pullback in the S&P 500 – the fourth longest streak since 1950. For global context, in the past 20 years, global stocks have not gone a calendar year without a 30-day pullback of at least 5%. Thus far in 2017, the biggest 30-day pullback was less than 1%. There are several theories as to why we have not seen significant, yet normal, corrective action for markets over the past few years. Increasing reliance on passive management and simple rotation styles may mean that sellers have been muted, putting a natural floor of prices. Essentially, as long as we remain in a bull market and fundamentals remain positive, it seems that the buy-the-dip philosophy will be rewarded.
What makes a market is supply and demand, so low volatility will not last forever. There are times when it pays to be more heavily invested and other times where it pays to lighten up and protect your assets. This is why we have always adopted an active asset management approach. By observing present conditions, such as valuation, investor psychology, political policy, short-term economic trends, or long-term fundamental tailwinds, we are committed to actively adjust investment exposure for superior risk-return prospects. With proper stock selection and supplemental option strategies for added value, we feel that equities will continue to play an important role in driving returns for investors.