April Private Client Letter
Fundamentals Remain Intact
Over the past several months we have been making the case that an important shift in our economy had begun. Led by a trend of stronger economic fundamentals and the anticipation of pro-growth government policies, we find ourselves operating within an environment that feels very different from where we were just six months ago.
We believe these policies will spur an acceleration of economic growth and a sustained period of greater prosperity. Not surprisingly, we believe a new leg of the bull market is just beginning and could extend for several years into the future.
As we have previously noted, this has been the slowest recovery on record. Had the economy instead regained its long-term average growth rate of 3.1% per year, the economy today would be roughly $3 trillion dollars bigger. Applying simple reversion-to-mean theory, one can see that our economy has a lot of lost ground to make up. It also explains why we believe the shift back to pro-growth policies is so noteworthy.
Equity markets appear to share our constructive view, as stock prices have been riding an impressive wave of momentum following the presidential election last November. For the first quarter stocks posted notable gains with the Dow Jones Industrial Average (DJIA) crossing both the 20,000 and 21,000 thresholds. The S&P 500 achieved its own milestone, recording a run of 50 consecutive trading sessions without a daily swing of more than 1.0%. For the quarter, each of the major indexes advanced, with the NASDAQ leading the way posting gains close to 10.0% and the S&P 500 reaching its largest quarterly gain in almost two years.
We continue to reject the notion that the equity prices are unwarranted, or simply explained by unsupported optimism. The markets are usually quite reliable at identifying developments that are not yet obvious in the statistics, and we feel rising stock prices are the logical response to an improvement in economic fundamentals that is gradually becoming more obvious.
As investors, we are always focused on valuations and must ask ourselves if prices have become stretched. Corporate profits are the key consideration in answering this question and when properly adjusted (for taxes, inventory and capital allowances), profits are historically quite strong (Art Lafer). In fact, equity valuations are now only modestly above long-term averages and have actually been higher more than 25% of the time over the past three decades (Bespoke).
Economic activity drives corporate profits and the fundamentals continue to be encouraging. According to the latest Manufacturing ISM Report on Business, the manufacturing sector expanded in March and the overall economy grew for the 94th consecutive month. Of the 18 manufacturing industries, 17 reported growth in March and all 18 industries reported growth in new orders. Recent strength in the ISM index is consistent with the pace of GDP growth eventually rising to better than 3%, substantially higher than the fourth quarter growth of 2.1%.
The ISM manufacturing data also revealed a strong reading for export orders, indicating improving circumstances overseas. It is nice to see that manufacturing conditions are progressing globally as coordinated recoveries can become self-reinforcing. Manufacturing businesses are also becoming more confident about the future as reflected in a strong ISM employment reading. Lastly, ISM data has a strong tendency to lead year-over-year gains in S&P 500 revenue and is currently pointing to further strength in corporate profits.
April promises to be a news filled month, with several potentially market-moving global events to monitor closely. First quarter 2017 earnings season begins in the second week and starts in earnest on April 13th when several big banks will report. Estimates for first quarter earnings growth is a very solid 10.2%, according to Thomson Reuters data. We would not be surprised to see earnings growth potentially in the 12 – 14% range when all results are in. Financials, technology, and energy are expected to be the biggest contributors to overall earnings growth.
Much of the current environment continues to be dominated by the deeply divided politics of our country. With the recent failure of the House Republicans to advance health care reforms, tax reforms become somewhat more complicated. A major component of the American Health Care Act was deep cuts to Medicaid and without that baseline reduction policymakers will be under great pressure to find other revenue offsets. The good news is that virtually all Republicans and many Democrats see the need for substantial reform.
On April 28, the current temporary spending bill to fund the government expires, creating the prospect of a government shutdown. In order to avert a shutdown, Congress will have to pass a new continuing resolution to extend funding. The simplest continuing resolutions extend government funding at current levels, but continuing resolutions can also include modifications or added provisions that can lead to potential conflict.
Odds of a shutdown are low this time around, with Republicans likely to avoid a legislative path that can easily be framed as an inability to govern. Even with a shutdown unlikely, escalating political tensions could unsettle markets given the already uncertain policy environment; but without further catalysts, any market retreat is likely to quickly reverse as tensions settle.
In closing, we would highlight the seasonality factor surrounding the month of April, when history tends to side with the stock market bulls. In fact, going back 20 years, the S&P 500 has averaged a 2.0% gain during the month, the best out of all 12 months. Going back to 1950, the S&P 500 has been up 1.5% on average during April, behind only November and December. Performance during a post-election year has been slightly better than average, up 1.6% on average. Over the last 20 years, April has been up an astounding 80% of the time. (Source: LPL Research)
Where things get interesting is after a big first quarter, performance has become even better. In fact, since 1950, the S&P 500 has gained more than 5% in the first quarter 24 previous times (excluding first quarter of 2017), with April higher by an average of 2.0% during those years.
It will be interesting to see how the month plays out. Regardless, we continue to believe the weight of data supports our current positioning and our generally constructive view of the equity markets over the next two to three years. While we are always mindful of those events which could temporarily disrupt our path forward, we remain focused on longer-term factors that we believe remain quite favorable.
Thank you for your continued trust and confidence.
John Chapman, April 2017
John E. Chapman
John is the Chief Executive Officer at Clearwater Capital Partners and serves as the firm’s Managing Partner. With thirty four years of Wall Street experience, John directs all wealth management and advisory services for the firm. He also serves as the firm’s Chief Investment Strategist and chairs the firm’s Investment Policy Committee.
THIS COMMENTARY HAS BEEN PREPARED BY BSC PRIVATE WEALTH MANAGEMENT, LLC. THE OPINIONS VOICED IN THIS MATERIAL ARE FOR GENERAL INFORMATION ONLY AND ARE NOT INTENDED TO PROVIDE OR BE CONSTRUED AS PROVIDING SPECIFIC INVESTMENT ADVICE OR RECOMMENDATIONS FOR ANY INDIVIDUAL.
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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 2017, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BSC Private Wealth Management, LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.