Pulse Points > March Investments & Market Update
Gill Capital Partners March 2017 Market Commentary
The “hope rally” that we described last month, which began after the election, has generally continued over the past month. As of this writing the S&P 500 is up 6.5% year to date, and international and emerging market equities are up 5% and 9.5% respectively. The bond markets are essentially flat for the year. Various reports on the state of the economy continue to show improvement, most notably the recent release of the monthly jobs report by the Bureau of Labor Statistics (BLS), which showed the economy added a robust 235,000 jobs in the month of February, well above expectations. We continue to hear concerns as to the sustainability of this rally, particularly as it relates to ongoing headlines coming out of Washington and the Trump administration that are often times confounding and concerning.
It can be difficult as an investor to establish an investment thesis that is not influenced by one’s own political views. As we outlined last month, This market is being fueled by optimism that the Trump administration, along with a republican controlled Congress, will be able to reduce corporate regulations, enact tax reform, repatriate corporate cash, and increase infrastructure spending. Irrespective of the level of one’s support for these issues, there is no doubt that the market currently views them as supportive of growth. We mentioned last month that the rally up until this point has been driven by the hope that these items will become reality, and that hope will need to give way to reality in order for the rally to be sustained. We continue to believe that, but our focus has turned to one issue in particular that we believe to be supremely important to this rally: tax reform. To the degree that the Trump administration is able to enact tax reform quickly and substantively, our investment committee believes that this rally will continue to find support. However, if tax reform begins to slip and become compromised via horse trading within the political machine, we would become concerned that this rally can continue.
Interest Rates & The Federal Reserve
On Wednesday March 15th, as widely anticipated, the Federal Reserve announced it would raise short-term interest rates and set the expectation for further increases this year, citing economic and financial system improvement. Fed Chairwoman Janet Yellen said “The simple message is the economy is doing well, we have confidence in the robustness of the economy and its resilience to shocks.” Equity markets rallied sharply and interest rates dropped following the Fed’s announcement as some investors were fearful that the Federal Reserve might take a more aggressive tone of the Federal Reserve.
We hear a lot of concern about interest rates moving higher over the coming years and what impact higher rates will have on real estate, borrowing, and fixed income investments. Remember, most interest rate markets (outside of the Federal Funds rate) are anticipatory markets and are not controlled by the Federal Reserve. These markets adjust on a real-time basis to reflect an equilibrium of all known information and expectations. It is generally accepted that markets have already adjusted to what they anticipate the Fed doing with short-term interest rates over the next year or two. We have seen rates move higher by roughly 100 basis points, from 1.5% to 2.5% on the 10-year U.S. Treasury. That is a significant move and is reflective of the expectation for two to three more rate hikes over the next year by the Federal Reserve. Interest rates may move higher from here, but that would have to be accompanied by continued economic strength and inflationary pressures such that the market would expect more aggressive action by the Federal Reserve than what is currently being forecasted. While we certainly wouldn’t rule this out, we see plenty of reason for a more moderate outlook in which the Fed would not drive interest rates aggressively higher, but continue to take a methodical and conservative approach to raising rates going forward.
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