By Stephen Kyne
We’re halfway through 2017, so it’s time to take a look at how the year is progressing, and where we see the remainder of the year going, in terms of risks and opportunities in the economy.
The economy has grown at a faster-than-expected pace so far this year. First quarter GDP has been revised up, twice, and well exceeds expectations. Almost all of the S&P has reported earning for its first fiscal quarter of the year, and are trending toward a year-over-year growth of upwards of 20 percent (12 percent, not including the energy sector). These are largely due to top line revenue increases, meaning that increased profits are largely due to business growth, rather than cost cutting. We expect this trend to continue throughout the year.
Inflation is holding steady, in line with 2016 figures, at roughly 2 percent. Some inflation, perhaps counter-intuitively, is fundamentally good for the economy. When we expect goods and services to be more expensive tomorrow than they are today, we make purchases today, which means inventories need to be replenished, which puts people to work and gives them money to spend on the things they want and need. Without some inflation, the economy stagnates.
Another driver of spending this year may be interest rates. The Fed increased rates another .25 percent in June, as was expected. With the Fed finally making good on promises to increase the rates they charge banks, we’ll see that increase reflected in higher mortgage rates. The expectation of higher future rates pushes fence-sitting potential buyers into the housing market. As a result we’ve seen, and will likely continue to see, increased sales of new and previously owned homes. The same will likely be true of any purchases which are typically made on credit, including automobiles and business capital items.
An asset class that may be hurt by rising interest rates, however, would be bonds – specifically many bond funds. As newly issued bonds carry higher interest rates, the value of previously issued bonds, with relatively lower interest rates, should decrease. These changes should be reflected in the overall value of the funds that hold them.
A downside of mutual fund investing is that, even though you may watch your values decrease, any gains the funds may have recognized from any of its holdings would be passed on to you. In other words, depending on timing, you can lose money and end up paying taxes for the privilege.
That being said, this is not a call to get out bonds completely. Fixed income investments are an important component of most asset allocations, and typically perform less-well as economies improve and stock markets rise, yet they can act as a ballast when the inevitable downturn occurs.
For the stock markets, 2017 has been a phenomenal year, with indices at or near record highs, in spite of media claims that the current administration would ruin the economy. While it remains to be seen whether the administration will help the economy, it certainly doesn’t seem to be slowing it down. In the end, expected policy changes and tax reforms, in addition to increased business cycle activity, seem to be the primary drivers of these gains.
For the U.S. stock markets, we think 2017 will continue to be a profitable year, with returns easily in the 10 percent range, although that bullishness must be qualified as we weigh President Trump’s ability to deliver on his promises to decrease corporate taxes, reduce inhibitive regulation, and reform prohibitive policies. If he is able to work with Congress and deliver, even moderate, reforms, the economy should continue to respond well. Alternatively, if government continues to be mired in gridlock, we expect more of the same slow growth.
If Republicans overplay their hand, as Democrats did in 2009, with an undue emphasis on social, rather than economic policy, we would expect the markets to act reflexively. A lot will become more clear as the first year of the administration continues.
Specifically, we feel there is opportunity in small and mid-sized U.S. companies in the coming year, for several reasons. These companies tend to operate domestically, and would likely be less impacted by international strife. Additionally, these companies are less likely to be impacted by any retaliatory tariffs, if the new President makes good on some of his more isolationist rhetoric. Thirdly, the value of the U.S. dollar has increased substantially relative to other currencies, making U.S. exports relatively more expensive, even without tariffs, which should have a more limited impact on companies operating largely within the U.S.
Internationally, we expect more of the same: countries doing well should continue to do so, those in trouble are unlikely to see much relief.
Thanks to victories by moderate, mainstream parties, largely in France, we believe significant stability is returning to the Eurozone. Large economies in the zone are likely to fare better, including the UK, Germany and France, but we still are shy to invest in the smaller, less stable countries, including Greece.
With the exception of some of the smaller Southeast Asian nations, we are not overly optimistic about Emerging Market economies. The situation in many of the Latin American nations continues to erode. Growth in China continues to slow. Russia will be an interesting economy to watch, as relations with the U.S. may change markedly with foreign policy adjustments likely to be made by President Trump.
From a fundamental standpoint, we believe the U.S. is the most advantageous place to be invested for growth, although we see increasing pockets of opportunities abroad. If changes promised by the new U.S. administration come to fruition, American companies, their employees, and shareholders stand to be the biggest winners, along with foreign nations whose interests are aligned with the U.S.
That being said, these are forward-looking statement, any number of domestic and international events could drastically alter this outlook. Be sure to work closely with your independent advisor to help ensure your investment strategy accurately reflects your goals and any changes in the economic landscape.
Kyne is a Partner at Sterling Manor Financial in Saratoga Springs.