“Successful investing is about having people agree with you…later.”    — James Grant

 First Quarter Highlights

 Most financial markets rallied in the first three months of 2017. Equities continued their upward push following the Presidential election, with the U. S. and other developed markets as well as emerging stocks all delivering positive returns.

Sector performance showed some rotation from fall of last year.  Information Technology, Health Care and Consumer Discretionary led the way, while Energy and Telecomm lagged. Meanwhile, prices of fixed income securities bottomed by early March before moving higher.

Other asset classes were mixed.  Oil fell due to a ramp-up in American fracking production while copper, iron ore and precious metals such as gold, rose for the quarter. The U. S. dollar pulled back from its highs as China and emerging economies continued to improve.

The End of the Presidential Honeymoon and Its Aftermath

 A good deal of investor activity revolved around changing opinions about the “Trump trade”.  This included stocks that require a strengthening economy and those that benefit from an enactment of new policies such as tax reform  lowering overall corporate rates and allowing tax breaks on the repatriation of profits of foreign subsidiaries), deregulation and increased infrastructure spending. The failure to pass a new healthcare bill, a contentious Supreme Court nomination and other distracting delays of the Administration’s agenda also had an impact on the investment market. As a result, buying has returned to growth equities, which do well even in a moderate growth economy, as opposed to value and cyclical stocks.

At the same time, emphasis on fiscal policy gave the Federal Reserve the opportunity to raise the Federal Funds rate in March and maintain a course to raise rates two more times this year. The Fed is also considering shrinking its huge $4.5 trillion balance sheet over time, beginning as early as late this year.  This approach, recently suggested by New York Fed President William Dudley, would take the place of additional rate hikes, as it is another form of “tightening.”

Curiously, the economy has so far displayed the same pattern of growth that has characterized most of its expansion.

  • The first quarter looks to be anemic, due once again to weather factors and late timing of tax refunds.
  • The rest of this year will likely feature a snapback, leaving 2017 real GDP increasing at the same 2.0-2.2% pace as previous years.
  • Any bump in growth attributed to expansionary fiscal policy will most likely be felt either in the autumn or in 2018.

The forecast for corporate profits however, is a bit more sanguine.

  • S&P 500 earnings are slated to increase 10-11% from either the top-down (macroeconomic view) or the bottom-up (analyst) consensus.
  • Revenue growth is also expected to return after almost a two-year hiatus. Two major reasons for the increase are: 1) an improvement in energy company results due to a bottoming in oil prices early in 2016; 2) a better global economy.

Locally, Hawaii’s economy is being helped by a record 2016 increase in tourist arrivals. However, housing affordability and widespread traffic problems continue to plague the state, and may temper near term economic growth.

Looking Ahead

 We maintain the view that the U. S. economy is in the mid-stages of an expansion. Though chronologically it is eight years old, the expansion has grown more slowly than previous growth cycles. The excesses that manifest themselves just prior to a recession are still not there. Likewise, signs of excess in the equity market are largely absent.

We continue to tilt portfolios toward equities over fixed income, especially with the Fed still in the early stages of raising rates. Though there may be a pullback in stocks from their recent gains, it should be thought of as a buying opportunity rather than the beginning of a bear market.

Tax reform will probably be realized, although in a more diluted form. Less regulation should be easier to accomplish, since it does not require Congressional legislation. Ten-year yields should eventually resume their climb towards 3.00%, and global markets overall should continue to move higher for at least the intermediate term.