Midyear 2017 investment outlook
Brian Kilb: Kyle, a surprisingly good first half of the year for the Brewers.
Kyle Tetting: Yeah, it absolutely has been.
Brian: I think we can say the same for the stock market. The Nasdaq’s up, what, 15%; the Dow, the S&P, give-or-take, 9-10%. A pretty surprising first half, but, really, if you look at what happened in the first six months of the year and you strip away all the peripheral noise, it really was about interest rates and earnings.
Kyle: You’re absolutely right, Brian. We haven’t seen a lot of movement on the political front. We haven’t seen a lot of movement on the economy. Certainly some continued, slow progress there, but it really has been the earnings piece that’s driven returns.
You know, 15% earnings growth in the first quarter is exceptional. You look ahead to the full-year 2017, full-year 2018, even full-year 2019, we’re talking about maybe low double-digit returns each of those years. And so I think the 10% or so returns on the S&P have been warranted so far.
Brian: You know, Kyle, now eight, nine years into this recovery/expansion, people are a little bit concerned about valuations with forward-looking price-to-earnings ratios in the 17-18 range, and yet I don’t know that I’m as concerned about valuations as many because of those anticipated growing earnings.
Kyle: I think more importantly, though, it’s the low interest rates that have supported those higher valuations recently.
And the other thing is, we don’t expect markets to simply fall apart because valuations have gotten a little bit high. It’s really going to be some kind of catalyst that turns things the other direction.
Brian: So, switching to interest rates a little bit. As we consider what rising interest rates do, the fascinating thing in the first six months for many people would be to recognize that actually long-term interest rates have held steady. Low interest rate environment, strong earnings environment, not a surprise that stocks have done quite well.
Kyle: So, you look at that short end. We’ve seen interest rates rise a little bit as the Fed has increased the overnight rate a couple of times. But you look at those longer rates, as you mentioned, with the expectation that inflation doesn’t really take off here anytime soon. It’s allowed the 10-year and even longer-term bonds to come down a little bit, changed that yield curve from a little bit steeper to a little bit flatter, and ultimately it’s really been a boon for bond investors.
Brian: I think the lack of inflation right now is something that gives the Fed a great deal of wiggle room as they consider monetary policy moving forward. Maybe they aren’t forced as much to raise rates at the pace that they may have in other cycles.
Kyle: Yes, and the other thing we’re looking at right now is what the Fed’s going to do with their balance sheet. So I think inflation becomes the piece that really allows them the leeway they need to normalize not just the overnight rate but also to normalize the balance sheet.
So we’re talking about trillions of dollars in assets sitting on that balance sheet that may be unwound, but probably going to be unwound over a very long period of time. And so, they’ve given themselves a lot of time to digest what might happen with inflation, not just today, tomorrow, but even well into the future.
Brian: I think, as we kind of transition into thinking about the future, one of the things to watch in that regard, Kyle, is synchronous global growth.
You’ve got the fact that in the first quarter, you had all seven international economic regions pulling in the same direction for the first time since 2010. So these things start to kind of feed off on themselves. I think that’s, uh, maybe one of the better stories in terms of optimism going forward.
Kyle: Absolutely. We’ve been looking at Europe in particular, which had been a pretty big net detractor from global growth. But I think that we’ve had some really positive signs there.
You look at Japan as well, and I think that’s been a story that for decades now, we’ve seen deflationary pressure. We’ve seen some concerns about growth. And yet they’re doing all right as well.
Brian: And maybe one of the big stories in the first half was the lack of volatility. You go back to the first quarter, measure volatility – the lowest since the ‘60s. Now, as we kind of anticipate what may happen in the months ahead, it’s hard to think that it may stay that low. So, something to watch in terms of volatility there, but it’s been a pretty quiet first half.
Kyle: You know, Brian, I think what we’re missing out on right now – because volatility has been so low because we’ve traded in such a narrow range – is the kind of probability that some of those outsized events are going to happen. And so I think that’s where my concern lies right now is on this idea that we might see something unexpected that could pretty significantly drive returns one way or the other.
Brian: We’ve had a pretty good six months or 12 months. And, as a result, if you were leaning into stocks over the last couple of years based on strong valuations and good opportunities in an improving economy, you may be a little rich in stocks right now. It maybe not a bad time to take some profits.
Kyle: The reality is most clients don’t need all their portfolio tomorrow. They need a portion of their portfolio tomorrow. And so now’s a great time to make sure they have that portion ready to go for tomorrow, let the rest of that stuff ride. Make sure you’ve got your short-term money safe, but keep that long-term money invested.
Brian: So, if we can keep the returns from the first half and maybe make a couple of nickels with interest rates or dividends or otherwise, we’d consider it a successful year. A lot of things going on. As always, I’m looking forward to seeing how the second half of the year plays out.
Federal Reserve holdings: What to know, a Money Talk Video with Marc Amateis
Investing amid synchronized global growth, a Money Talk Video with Marc Amateis
The ups and downs of volatility, a Money Talk Video with Steve Giles
Rebalancing: More investing, less emotion, a Money Talk Video with Steve Giles
(initially posted July 27, 2017)