The first quarter of 2017 is over. The talking heads on TV have been calling for a drop in the stock market for the past five years. And yet it keeps chugging along.
The 10-year US treasury spiked from a low of 1.3% last July to 2.6% this year, on the anticipation of Trump’s tax cuts and infrastructure spending. It’s since fallen to 2.3%. This decline is notable since it occurred AFTER the Federal Reserve actually raised short-term interest rates last month.
While it is widely believed that interest rates (and also mortgage rates) are heading higher over the long term, the rate of increase is likely to be extremely slow.
Compared to Germany and Japan, who’s 10 year bonds yield an unremarkable 0.3% and 0.07% respectively, US yields are significantly higher. Against this global backdrop, demand for higher yields is strong which will keep US interest rates from rising too fast. I expect it’ll be at least 2022 before we see the 10-year treasury at 5%.
Despite this slow pace, higher interest rates are coming.
Bond prices are inversely proportional to interest rates, which means prices fall when interest rates rise. To help combat this decline to our bond allocations, we recently added some floating-rate bonds to our long-term portfolios. These bonds will rise along with rising interest rates.
The two main drivers of the economy, businesses and consumers look like they are finally turning a corner.
In Q4 2016, corporate profits jumped a remarkable 22% from the prior year. This jump is likely to kick-start corporate spending, something that has been missing from the economic recovery since the Great Recession ended eight years ago. As a result, we are likely to see hundreds of millions (if not billions) of dollars in spending, as businesses invest in themselves. This will lead to increases in productivity, helping lower costs and spurring job creation.
Also, the consumer sentiment index, a gauge of the consumer’s expectations regarding the economy, is at it’s highest rate since 2004. This usually corresponds to an increase in consumer spending.
Unemployment is at the lowest point in a decade, and we’re finally seeing signs of wage growth as well.
Coupled with low inflation and low interest rates, this rise in income should help boost economic growth beyond the lukewarm 1-2% we’ve seen for the past several years.
As the economy continues to improve and with no signs of a recession on the horizon, I expect the stock market to continue to perform well. While some of the future growth may already be baked into today’s prices, the risk of a major stock market decline is low.
By major, I mean a 20% or more drop. Drops of 5-10% occur pretty much every year and should to be expected.
Of course, our political situation remains a wild card. But as I’ve explained before, we don’t make investment decisions based on political events.
As of April 9th, nearly all asset classes are positive year-to-date:
S&P 500 ended up 5.7%
Mid-cap stocks up 5.6%
Small-cap stocks 3.9%
US Real Estate 1.9%
Foreign Real Estate 5.1%
Developed Market Stocks 7.2%
Emerging Market Stocks 12.8%
US Bonds 0.8%
Emerging Market Bonds 3.7%
High Yield Bonds 9.6%
Floating-Rate Bonds -0.7%
Gold 9%
Gold Mining Stocks 9.7%
Commodities -0.1%
The only exceptions were commodities and floating-rate bonds with a minuscule loss.
After five years of subpar performance, Emerging Markets were the best performers. For various reasons, which I’ll explain in the near future, this trend is likely to continue. We’ll be modifying our portfolios slightly to benefit from this trend.
Tax season is almost over. If you’re planning on making 2016 contributions to your IRA, you have until the tax-filing deadline, which is April 18th this year.
Wish you all a Happy Easter!
Nirav
P.S: If you’d like to discuss your investment performance, or you’d like a complimentary portfolio review, use this contact form and we’ll schedule a time to talk.