Generous First Quarter – Domestic Equity Update

The first quarter saw all of the major equity indices end positive, with the Dow Jones Industrial Index ending up 4.6%, the S&P 500 Index returned 5.5%, and the Nasdaq ended the quarter with a 9.8% gain. The S&P 500 index peaked on March 1^st, ending lower at quarter end yet still up for the quarter as its sixth straight positive quarter.

What was of interest regarding the positive outcome in the first quarter was that the market’s performance was not due to the Trump sector stocks that excelled following the election, which were actually lack luster during the 1^st quarter. Technology underperformed after the election but had the single largest return of any of the sectors. The technology sector led the 1^st quarter rally, producing the largest gain of any of the industry sectors.

On March 22^nd, the Securities & Exchange Commission (SEC) adopted a rule to shorten the settlement period for securities from 3 business days to 2 business days. The SEC believes that a shorter settlement period will reduce certain credit, market, and liquidity risks. The new rule will take affect September 5, 2017. (Sources: SEC, Dow Jones, S&P)

Rates On Track To Rise Slowly – Fixed Income Overview

Rates retreated downward during the first quarter as growth prospects were alleviated even though the Federal Reserve raised rates in March. Treasury bond yields rose in early March in anticipation of accelerated Federal Reserve tightening and then fell following a sense that the Fed may proceed with cautioned rate hikes due to possible lackluster economic data. The Fed increased its target on short-term rates (Federal Funds Rate) to 0.75-1.0% and signaled two more anticipated hikes in 2017.

A jump in the Personal Consumption Expenditure (PCE) index to 2.1% has validated the Fed’s stance of continued rate hikes and an eventual winding down of its government and mortgage bond holdings on its $4.5 trillion balance sheet. (Sources: Federal Reserve, Reuters, Bloomberg)

Brexit Is Finally Underway – Euro Region Update

Ever since British voters decided to have Britain exit the European Union (EU) in June 2016, the process and timeline of the exit have been in question. This past month, British Prime Minister Theresa May triggered Article 50 which begins a two-year period of negotiations with the EU on exiting the union and establishing remediary trade arrangements with applicable countries. Should negotiations not be completed within the two-year period, then Britain would be required to follow World Trade Organization (WTO) rules on tariffs.

What has kept Britain from formally moving forward with its decision to exit the EU has been the delay in executing Article 50, which was never signed by the prior prime minister, David Cameron, and delayed by British courts on its applicability.

The execution of Article 50 comes at a time when other EU member countries are having elections with EU membership as a notable topic.

Here in the United States, triggering Article 50 is akin to having a U.S. state secede from the nation. (Sources: EuroStat, Europa.eu)

Auto Sales May Have Peaked – Industry Overview

Low interest rates and aggressive leasing programs have made some fairly expensive cars affordable. Rather than struggling to get approved for a new home loan or refinance, Americans have instead financed cars, where getting a loan approval has been easier. The abundance of attractive loans has helped elevate auto sales throughout the country over the past few years. Recent auto sales have been slowing across the country as dealer incentives have become less effective.

The end of 2016 saw auto loans outstanding reach $1.1 trillion, propelled by continued low interest rates. Federal Reserve data revealed that the average rate on a typical 4 year auto loan was 4.45% in the 4^th quarter of 2016. The same auto loan in February 1982 was 17.05%.

As expensive as some automobiles have become for consumers, an auto loan is the only method of actually affording the pricey cars of today. Over the years, several automobile companies have established their own financing thus allowing buyers to buy and borrow directly from them.

A growing concern among analysts are the number of auto loans that have been securitized over the past few years. The ultra low rate environment has created incredible affordability for consumers as well as attractive high yielding securities for risk seeking investors. An increase in rates may lead to an increase in auto loan defaults as payments become less affordable. (Source: Federal Reserve)

Inflation On Track For Fed Rate Hikes – Monetary Policy

A primary determinant for the Fed’s decision to raise rates is inflation. As part of its monetary policy objectives, the Fed had set a 2% target for consumer inflation as a trigger for sustained rate increases.

A closely followed indicator of inflation and what consumers pay for goods and services is the Personal Consumption Expenditures Index (PCE), which is compiled and released by the Commerce Department each month. The most recent data released shows that consumer inflation edged up 2.1% over the past year, marking its largest annual gain since March 2012.

A rising PCE is indicative of rising prices for consumers throughout the economy, in other words inflation. One of the Fed’s mandates is to thwart inflationary pressures with gradual increases in short-term rates. This monetary policy tool has been used for decades as it stems inflation and slows consumers down from spending too much before it evolves into inflation. (Sources: Commerce Dept., Fed.)

Tax Freedom Day – Market Fact

Every year, the nation celebrates Tax Freedom Day, the day that the nation as a whole has earned enough to pay for all taxes due throughout the year. This year, Tax Freedom Day is April 24^th.

The Tax Foundation calculates Tax Freedom Day by using the total amount of taxes paid the previous year then considers historical trends and recent economic data.

For 2016, the Foundation projected $3.3 trillion in federal taxes and $1.6 trillion in state and local taxes. The total of $5 trillion is then divided by the total personal income earned by Americans each year, deriving a ratio of 31. This number means that Americans work a third of their lives just to pay taxes. Once the ratio of 31 is multiplied by 365 days, then that’s how we arrive at April 24^th.

From a calendar perspective, January income is for federal income taxes, February is for Social Security, Medicare, and payroll taxes. March income is for state, excise and property taxes, while April is for the incidental corporate, estate tax and motor vehicle fees.

Taxes due from state to state vary considerably, since some states carry higher taxes than others. Residents from certain states such as Connecticut, New York, and New New Jersey may not celebrate Tax Freedom Day until May, while Louisiana celebrates it in late March. (Sources: IRS, The Tax Foundation)

Consumer Confidence On The Rise – Consumer Behavior

Two key measures of consumer confidence soared to levels not seen since 2000, helping to propel equities higher towards the end of the first quarter. Since consumer expenditures make up nearly 70% of Gross Domestic Production (GDP),growing confidence among consumers is viewed optimistically by economists.

A non-profit research group, The Conference Board, compiles and releases its Consumer Confidence Index each month, an indicator of consumer sentiment. In its most recent release, the Conference Board saw the largest increase in its index since December 2000. Another highly regarded index on consumer confidence is the Consumer Sentiment Index from the University of Michigan, which saw its largest increase in 17 years. (Sources: Commerce Department, Univ. of Michigan, Conference Board)

Brexit Is Beginning (by Bob Veres)

If you have a good long memory, you may recall that last Summer, the U.K. panicked the investment markets by voting, in a nation-wide referendum, to exit the European Union.  There were, of course, dire predictions about the impact on the U.K. economy, which never materialized, in large part because the U.K. had not yet formally opted out of its Eurozone agreements.

At the end of March, the U.K. finally pulled the trigger, and made the departure from the European Union official.  The Queen of England delivered her royal assent, and the U.K.’s envoy to the European Union handed-delivered a letter to the office of the European Council president in Brussels invoking Article 50 of the EU treaty.  This delivered formal notification of the Brexit decision, the first time this has happened in the EU’s history. 

So that means those dire predictions will finally come true.  Right?

As it happens, Article 50 was intended to prevent any rash or immediate consequences of an exit from EU membership, and it seems to have accomplished that goal.  Under the bylaws, the divorce will be negotiated, item by item, over the next two years, meaning that any change in economic circumstances will be gradual and perhaps accommodated as they happen.  How gradual?  Over the next several weeks, the EU’s remaining 27 members will discuss their priorities in advance of the negotiations, and then hold a summit on April 29.  Only then will the European Commission have a mandate to negotiate with representatives from London.

What will the negotiations cover?  First up will be Britain’s obligations to the EU for its participation thus far—a bill that could total up to roughly $65 billion.  Also: what will be the rights of 3 million EU citizens living in the U.K., and the rights of more than 1 million Britons living and working in the Eurozone?

After that, it is speculated that the British government will seek to negotiate a broad free-trade agreement which will effectively replicate the provisions of its former membership in the European Union, as a way to protect its commercial ties with the Continent.  This is where negotiations will get sticky, since France and Germany will almost certainly oppose a no-consequences exit, and they will want to protect their own economies’ free-trade access to Eurozone markets.  On the EU side, a simple majority of countries will decide what proposals are accepted and which are sent back to the negotiating table—with one notable exception: any free trade agreement between the two sides must win unanimous approval.

Brexit is Beginning (by Bob Veres)

This latter issue is problematic for the U.K., because it exposes each country to yet another referendum on the conditions of EU membership; the citizens of France, Germany, Luxembourg, Ireland, Holland and, well, all the other nations would want to be involved in the final decision, which would give them yet another opportunity to voice displeasure with the EU and stir up nationalistic parties and sentiments.

Also still to be determined are budgetary considerations.  The U.K.’s contribution to the governing infrastructure of the EU will have to be made up by the remaining members, whose citizens are not eager to contribute more to the increasingly unpopular entity.  The British government, meanwhile, will have to create an expensive governance infrastructure to replace the EU bureaucracy in Brussels, and Parliament will have to formally repeal the European Communities Act of 1972, making EU law U.K. law.  Then, parallel with the EU negotiations, Parliament will debate every aspect of the EU law and decide which to keep long-term and which to drop.  That, too, will take years.

The bottom line is that nothing dramatic is likely to happen, economically and in the investment markets, for years.  Throughout the two years of negotiations, the U.K. will remain a full EU member, albeit without a chance to participate in EU decision-making.  Some are predicting that the discussions will last for several additional years, with extensions on the status quo until issues can be ironed out.  Unpicking 43 years of treaties and agreements covering thousands of different subjects will not be an easy task. 

Those investors who overreacted to the initial (and shocking) Brexit vote sold their stocks into a market rally, and there is no reason to think that those who might panic now that the trigger is finally pulled will fare any differently.  Both sides in this negotiation have a stake in not having anything dramatic—particularly dramatically damaging—from happening, and they will probably succeed in making Brexit a boring exercise in bureaucratic handover.

Sources:

https://www.stratfor.com/geopolitical-diary/brexit-has-begun-now-what?utm_source=Twitter&utm_medium=social&utm_campaign=article

https://www.theatlantic.com/news/archive/2017/03/brexit-faq/521175/?utm_source=atltw

2017 First Quarter Report (by Bob Veres)

Are we in the late stages of a bull market—that time when the market suddenly takes off like a rocket for no apparent reason?

Over the last eight years, the S&P 500 index has returned more than 300%  But the tail end of this run seems to have accelerated the trend.  The first quarter of 2017 provided the highest returns for U.S. large-cap stocks since the last three months of 2013.  The Nasdaq index has booked its 21st record close of the year so far, and the indices have recorded a 30% rise over the past six quarters, marking the fastest advance since 2006.

The first quarter of 2017 has seen the Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—rise 5.72%, while the comparable Russell 3000 index gained 5.91% in the first quarter. Looking at large cap stocks, the Wilshire U.S. Large Cap index gained 6.01% in the first quarter.  The Russell 1000 large-cap index finished the first quarter with a 6.23% performance, while the widely-quoted S&P 500 index of large company stocks was up 5.53% in the first three months of 2017. Meanwhile, the Russell Midcap Index gained 5.15% in the first quarter.

As measured by the Wilshire U.S. Small-Cap index, investors in smaller companies posted a relatively modest 2.26% gain over the first three months of the year.  The comparable Russell 2000 Small-Cap Index finished the quarter up 2.20%, while the technology-heavy Nasdaq Composite Index rose 9.83% in the first quarter, continuing its record-breaking climb.

Even the international investments were soaring through the start of the year.  The broad-based EAFE index of companies in developed foreign economies gained 6.47% in the first three months of calendar 2017.  In aggregate, European stocks gained 6.74% for the quarter, while EAFE’s Far East Index gained 5.13%.  Emerging market stocks of less developed countries, as represented by the EAFE EM index, rose 11.14%.

Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, eked out a 0.03% gain during the year’s first quarter.  The S&P GSCI index, which measures commodities returns, lost 2.51%, in part due to a 5.81% drop in the S&P crude oil index.  Gold prices shot up 8.64% for the quarter and silver gained 14.18%. In the bond markets, rates are incrementally rising from practically zero to not much more than zero. Coupon rates on 10-year Treasury bonds now stand at 2.39% a year, while 30-year government bond yields have risen to 3.01%.

The pundits on Wall Street have been telling us that the market’s sudden meteoric rise—which really accelerated starting in December of last year—is the result of the so-called “Trump Trade,” shorthand for an expectation that companies and individuals will soon be paying fewer taxes and be burdened by fewer regulations, leading to higher profits and greater overall prosperity. Add in a trillion dollars of promised infrastructure spending, and the expectation was an economic boom across virtually all sectors.

However, there is, as yet, no sign of that boom; just a continuation of the slow, steady recovery that the U.S. has experienced since 2009. The latest reports show that the U.S. gross domestic product—a broad measure of economic activity—grew just 1.6% last year, the most sluggish performance since 2011. The U.S. trade deficit widened in January, and both consumer spending and construction activities are weakening from slower-than-average growth rates.