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Newsletter – May 2017

Posted by Koenig Investment on
 May 4, 2017
  · No Comments

Interest Rates

This year’s economic activity actually started in December with a Fed announcement.  They expected to raise interest rates ¼ point at three different times in 2017, for a total expected rate increase of ¾%.  We then saw a large jump in the January inflation rate.  This news created a bit of a scare in the bond market as several analysts felt the Fed had underestimated inflation.  There was much speculation that more than three rate increases would be appropriate for 2017.  Subsequently inflation figures for both February and March showed much more subdued levels of inflation.  January is now viewed as a temporary spike that has not changed the overall expectation for 2017.  Rates should rise this year, but at the moderate pace originally outlined by the Fed in December.

There are two important metrics to keep in mind when evaluating bonds – interest rates and duration.  Duration is linked to how long a bond has until maturity.  The longer the duration, the less valuable the bond is during times of rising interest rates since newer bonds issued will pay an investor a higher interest rate.  We’ve rebalanced bond exposure to shorten duration given the anticipated rate rises.  We have also added exposure to floating rate bonds as their values hold up better during periods of rising rates.  Unlike traditional fixed rate bonds, floating rate bonds are tied to a benchmark such as LIBOR, Fed Fund or prime rate.  These benchmarks can adjust quickly with changes in interest rates. 

International

International stocks have underperformed U.S. stocks for the past few years.  It may come as a surprise for some investors that international equities have outperformed U.S. equities year-to-date in 2017.  The latest GDP figures coming out of Europe and Asia are starting to perk up and show signs of increased growth.  These improvements are represented in foreign stock price increases.  As of 4/28/17, the S&P 500 year-to-date return was 7.16%, while developed international markets (represented by the MSFCI EAFE index) have returned 9.97%.  The MSCI Emerging Markets index – which would include companies in such countries as South Korea, China, South Africa, and India – has returned 13.88% YTD.  Even with the recent move up in foreign prices, we find that international markets still have more attractive valuations and more room for growth than their U.S. counterparts.  Throughout 1st quarter 2017 we have increased our equity weightings in both international developed and emerging markets positions to take advantage of these growth opportunities. 

 Election Reforms

A reasonable case could be made that investors have been accumulating stocks in the aftermath of the November election in anticipation of a number of economic policy changes.  There is a wide expectation of a significantly lower corporate tax rate in the near future.  A reduction in individual tax rates could see discretionary income increase if personal taxes are reduced.  An opportunity to see a repatriation of a significant portion of the $2.5 trillion in U.S. based company profits residing abroad could benefit the economy if handled carefully.  Healthcare reform could be done in such a way as to benefit the economy.  Lastly, widely discussed infrastructure spending would be a shot in the arm to several economic sectors. 

Despite the widespread investor anticipation of movement on each of these items under a Republican president, congress, and senate the actually progress has been fairly slow to date.  It was hoped that tax reform would largely take shape in April.  That has not happened.  While some progress has been made on outlining changes to both the individual and corporate tax structures, many details have yet to be hammered out.  Previous foreign profit repatriation resulted largely in company stock buybacks rather than capital expenditures.  A plan that would both allow for repatriation and ensure that companies use this move for job creation has yet to be worked out.  Proposed healthcare changes ran into a very fragmented Republican congress and are still in limbo.  Tax changes may very well see the same multiple camps arguing over details, each demanding their view be adopted.  There are also concerns over the president’s tax changes significantly adding to the national debt.  Many conservative members of congress were elected on their pledges of fiscal responsibility and will only accept revenue neutral changes.  Finally, infrastructure spending involves a significant amount of planning and getting bids from various construction firms.  Analysts now do not expect to see the beginning of an infrastructure plan until 2018 at least.

 Economic Outlook

The outlook for 2017 real gross domestic product (GDP) is in the 2-3% range.  If tax reform is delayed until late 2017 or early 2018, the probability favors GDP to track towards the lower end of the 2-3% range.  Recent quarterly earnings have generally been better than expected.  While there are always winners and losers each quarter, our research services have shown a much longer list of winners than losers each day figures have been reported.  This does not mean we are seeing strong growth.  Technology companies in particular reported greater earnings this past quarter and the sector is poised for growth, but other sectors show a lack of revenue growth.  That lack of growth does not bode well for future earnings.

In summary, we are in a fairly mature economy, and are now in the 9th year of an expansion phase.  That does not mean we see any indications of a near-term precipitous drop in market values.  U.S. stocks are a bit expensive by historic standards, but not excessively so.  We did see an uptick in sentiment after the election amongst sectors of the population that buy stocks.  These positive hopes have yet to turn into concrete reality that will drive economic growth.  Positive sentiment is an emotionally based metric and can erode as easily as it grows, but that does not mean we should expect to see a market crash.  We are in a wait and see period in which economic policy changes that could affect the economy in several ways are pending.  It can be frustrating to wait for more concrete direction, but waiting periods do eventually end.  In the meantime, we have adjusted bond and international holdings for clients to reflect the movement we have seen in those sectors.  We remain in a “plow horse” economy, with slow, steady growth.  While that is not exciting, it is not a bad place to be.

 

The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different.  The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties.  Individuals are encouraged to seek advice from their own tax or legal counsel.  Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel.  Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities

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Categories : Newsletter
Tags : Economic Outlook, Election Reform, Financial Markets, interest rates, International Investing, newsletter, tax reform
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