Thurs, AUG 10th, 2017
Aggregate data in the second quarter remained broadly supportive of both economic expansion and a healthy stock market. The job market continues to thrive, balance sheets are strong, confidence is buoyant, inflation and interest rates remain muted, and monetary policy is still loose – albeit decisively on the path toward normalizing. And while the daily fixation with U.S. politics has not gone away in the 24-hour news cycle, financial market sensitivity to such noise has dampened. Not that we mind; a market more focused on the fundamentals – i.e., real economic data and corporate results – is a more attractive and rational market. Global economic growth continues to trend up. As we mentioned in our last quarterly missive, a synchronized global economic bounce appears to be taking place. In fact, it’s the first time in the contemporary recovery where we’ve experienced the majority of the world’s largest economic horses all pulling in the same direction.
Europe’s economic footing has improved, so much so that the European Central Bank is finally beginning to entertain gradually removing extraordinary monetary stimulus; Japanese manufacturing
is perking up and its economy seems to be in a moderate recovery; and China is … well … China, growing output around +6% with a government ready to turn the economic dials in either direction if required. Save for an unanticipated exogenous shock, the world economy looks as if it’s in decent shape. S&P 500 profit growth accelerated further in the first quarter (the most recent data available), and is expected to continue to rise throughout 2017. The +13.7% earnings growth rate logged in the first quarter was the best pace since 2011. It also marks the third straight quarter of accelerating profit growth. Despite all the bullish conversation around the potential for fiscal stimulus, it’s this profit growth in our view that has been the real driver of stock returns this year. Indeed, we remain dogged in our position that corporate profits do the heavy lifting with regards to stock prices. That said we do not anticipate earnings growth to continue its current energetic stride. Rather we believe that while the upward trajectory should stay intact, it will likely be closer to a normalized mid-single digit speed.
Equity valuations remain neither cheap nor expensive, in our view. Nevertheless it seems rare to find anyone who doesn’t think that stocks are too high or richly priced. This is likely a good contrarian indicator, and tells us a lot about the current state of the market. We both recognize and are attuned to the metrics that the bears point to suggesting an overvalued market. But there are many other metrics that show no such excess. When viewed comprehensively we continue to assert that valuations are sensible, particularly considering low interest rates, tepid inflation, and improved earnings growth.
Despite another rate hike of 0.25% in June monetary policy remains rather loose. And for the third time since December financial markets took the hike in stride as the collective belief has been that the Fed is raising rates for the “right reason” – that is, the general economy is fit and warrants such action. Under our baseline assumption that the U.S. economic expansion perseveres we think that the Fed is likely on the path towards further policy normalization, although perhaps at this point focusing more on reducing the size of their large balance sheet versus raising the Fed Funds rate. If correct, this policy shift could ultimately have a more direct impact (upward pressure) on longer-term interest rates.
Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group