ARQ Wealth Advisors Q1 2017 Commentary
by Richard Siegel, CFP®
Donald Trump’s election win last year was one for the history books. Political and financial news pundits had a field day attempting to explain away the phenomenon, and what his rise to power would mean for the country. Well, four months later not much has changed; You cannot turn on the television, pick up a newspaper, or surf the internet without being inundated with rhetoric and fear mongering from both sides of the aisle. Indeed, these are uncertain times. Over the next few months we will be faced with another debt ceiling discussion, health care and tax reform, trade negotiations and the French presidential election.
Politics aside, economic data has markedly improved. The labor market continues to improve, consumer confidence and retail sales have been beating forecasts, the housing market continues to impress, manufacturing data has picked up and finally business investment and sentiment is upbeat. It is our belief that the uptick in data is partially attributed to where we are in the economic cycle and partially attributed to the new administration’s pro-growth agenda. Regardless, we are of the opinion that U.S. economic fundamentals are solid.
Capital markets delivered strong returns during the quarter, with equities turning in the highest Q1 returns since 2013. Foreign markets on the whole outperformed domestic stocks and the fixed income market turned in decent numbers in the face of rising interest rates.
It appears that the U.S. equity market is at an inflection point. Valuations are slightly above long term averages. The question now becomes “does it make sense to take some risk off?” The answer is “yes and no.” On the one hand, economic data is accelerating, and according to Factset, corporate earnings growth for Q1 is estimated to be 9.1% higher than it was a year ago. Consequently, that would be the best earnings growth number since Q4 of 2011. The forward PE ratio on the S&P 500 is approximately 17.5, which is slightly above its 16.5 historical average, but we all know that it can go much higher as it did for example in March of 2000 when the forward PE on the S&P 500 was 27.2. Let me put that in perspective; If our market multiple reached that same level, the S&P would be at 3657 or 55% higher from here! We do not think that is likely to occur in the short term, so we have taken a neutral position meaning that we have sold equities around the margins during the quarter in favor of buying bonds that have underperformed for the last two quarters (Remember – sell high and buy low).
During the first three months of 2017, the U.S. dollar has shown a bit of weakness, giving back a small percentage of the huge gains it has made versus other major currencies over the past couple of years. Any dollar weakness can be a boost to non-dollar denominated investments. Even with the recent outperformance of foreign equities versus domestic markets, we maintain our belief that foreign equities on the whole represent a better value than U.S. stocks from a valuation standpoint.
Fixed Income Overview:
Bond prices have been very reactive to the news flow out of Washington DC. When Trump won the election last year, bond yields skyrocketed, pushing prices down. The cause of this was the perception that the new administration would ignite economic growth and create inflationary conditions. The benchmark 10-year Treasury yield rose from a low of 1.34% last year to a high of 2.62%, almost doubling. Since then the yield has been bouncing around, susceptible to every news story related to the Fed, Trump’s twitter feed, and partisan politics.
On average, the bond holdings in our strategies are yielding in the 2 – 3% range. Considering last summer it was 1.5 – 2.5%, we are satisfied with the upgrade in yields. We remain defensive in relation to interest rate risk, with an average duration in the 4 year range. For perspective, the U.S. Aggregate Bond benchmark has an average duration of 5.77 years, which is 31% higher than our risk exposure.
The bottom line is that U.S. economic data has improved on most fronts, corporate earnings are growing, and consumer and corporate sentiment is quite positive. We perceive that there is some risk that the new administration’s pro-growth policies may be slow to implement and/or could be revised. For that reason, we remain neutral in our conviction. Client portfolios therefore are invested to their target weightings with no excess risk exposure at this time.