2nd Quarter Market Commentary 2017

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Caution is Warranted

BY DARREN MUNN, CFA

For those who are parents, you know the feeling when you realize the house is quiet.  Too quiet.  You have been enjoying the peace and calm, but realize something is not right.  You want to believe it is because your children are angels and are playing nicely in their rooms, but your gut tells you that is not the case.  You go to explore and find your children have gotten into your lipstick and drawn all over the walls, or tried to baptize the cat in the toilet, or found your chocolate stash and decided to save you from all those unnecessary calories.  We have all heard of other cases where the result is more sinister, resulting in harm to the children. 

As a nearly 20 year investing veteran, I am having one of those moments now.  It is more than just a gut feeling – there are many indicators we follow that lend support to the notion that something is not right in the markets.  Things are calm and appear to be well, but under the surface, trouble may be brewing.  I believe the risk in the market at this point is quite elevated and any further gains experienced in the short term will likely be reversed when the market experiences some volatility. 

Is this a certainty?  Absolutely not – it is possible the market could keep chugging higher for quite some time.  However, I believe that is a low probability scenario.  I believe a more likely scenario is that we experience a 5-10% pullback in the market before the end of the year, wiping out about half of the gains since the election.  I don’t believe this is a “Johnny cut off his hand” scenario.  It is more like a “Johnny decided it would be fun to jump off the garage and broke his leg” scenario.  It will cause some pain in the short term, but will not cause permanent damage to a well-designed investment plan.

In reality, I believe it will create some great investing opportunities for us – we just have to be patient and disciplined to capitalize on them.  We have continued to raise or accumulate cash in many of our strategies so we have dry powder to take advantage of these opportunities for our clients.   

The second quarter was essentially a continuation of what we observed in the first quarter: market gains driven by a small number of stocks, unexciting economic growth, no progress on tax reform or health care reform, and the Federal Reserve raised interest rates another .25% in June.  

Geopolitical concerns continue to fester, but have not rattled the market.  Corporate profits showed strong growth in the 1st quarter (as expected) but likely grew at a slower pace in the 2nd quarter. 

As previously mentioned, last quarter the gains in the market were largely being driven by a small number of stock.  For example, from March 1, 2017 to July 31, 2017, one stock (Boeing) accounted for about half of the gain on the Dow Jones Industrial Average.  If you throw in one more stock (McDonalds), together they account for nearly 75% of the gains, meaning the other 28 stocks in the index only accounted for 25% of the gains. (Morningstar)

Positives

  • Employment continued to be steady with the unemployment rate at 4.4% in June. (U.S. DOL)

  • Low oil & gas prices continue to save money for consumers, but the savings have been shrinking.

  • We believe energy markets have stabilized and are near equilibrium.  We expect oil to stay in the $40-$60 range for the foreseeable future.

  • Housing has continued moderate--but choppy--growth.  Low interest rates have helped keep prices affordable.  (Barron’s)

  • Economic growth continued in the first quarter, but was very weak at 1.2%.    Initial readings for the 2nd quarter suggest a much better growth of 2.6%, following a similar patter we have seen over the last few years.

Challenges & Risks

  • Economic growth will likely trend in the 2% range in our opinion.

  •  Interest rates – the Federal Reserve raised interest rates again in June and expects at least one more increase this year.  In addition, they intend to start shrinking their balance sheet.  This is something that has never happened before and is a major factor in our concerns about the markets.

  • Government regulation is a potential huge drag.  Health care costs are continuing to rise significantly & government interference in several areas (finance, education, energy) continue to limit economic growth.  Will this improve in 2017? 

  • China, Europe, North Korea, & Russia – They have certainly been capturing headlines as expected, with more to come. 

Despite the concerns heighted above, we believe there is still a high likelihood of decent investment returns in the coming years.  We simply wanted to highlight some likely short-term concerns which explains why we have built larger than normal cash positions in some strategies. 

We will continue to monitor these developments closely and seek to use them to your advantage.  This is our mission!  Have a great summer!

Sources:

1)      Bloomberg

2)      Barron’s

Disclosures:

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.  This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client.  These materials are not intended as any form of substitute for individualized investment advice.  The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own.  Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors.  Camelot Portfolios LLC can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein. A486