July 2017
Market Update
(all values as of 10.30.2020)

Stock Indices:

Dow Jones 26,501
S&P 500 3,269
Nasdaq 10,911

Bond Sector Yields:

2 Yr Treasury 0.14%
10 Yr Treasury 0.88%
10 Yr Municipal 0.94%
High Yield 5.72%

YTD Market Returns:

Dow Jones -7.14%
S&P 500 1.21%
Nasdaq 21.61%
MSCI-EAFE -12.61%
MSCI-Europe -15.66%
MSCI-Pacific -7.42%
MSCI-Emg Mkt -1.00%
 
US Agg Bond 6.32%
US Corp Bond 6.45%
US Gov’t Bond 7.40%

Commodity Prices:

Gold 1,878
Silver 23.72
Oil (WTI) 35.71

Currencies:

Dollar / Euro 1.17
Dollar / Pound 1.29
Yen / Dollar 104.44
Dollar / Canadian 0.75
 

Macro Overview

International markets reacted in June as central banks throughout Europe and Asia signaled that monetary stimulus efforts were slowly being dispatched. The news propped up European currencies including the euro, pound, and Swiss franc as anticipated higher rates tend to bode well for currencies.

Central banks from around the world are slowly curtailing stimulus efforts and starting the process of normalizing global interest rates in a gradual fashion. The central banks of Canada, England, and Japan all indicated that less accommodation would be the objective going forward.

The combination of rising asset prices along with central bank tightening can be very unpredictable. Many suggest that ultra low and negative interest rates have elevated asset prices such as stocks, bonds, real estate, art and classic automobiles to unsustainable levels. As rates gradually begin to rise, it is expected to produce a gradual return to normalized asset prices worldwide.

The Fed raised its key short-term rate (Fed Funds Rate) to 1.25% in June, up from 1.0%, executing its second increase this year. The Fed also mentioned that it was still on course to start unwinding its $4.5 trillion balance sheet towards the end of the year, composed of U.S. Treasuries and mortgages.

The Fed is viewed at odds with inflation expectations as it executes on gradual rate hikes with the anticipation of rising inflation. The concern is that inflation estimates by analysts as well as the Department of Commerce are muted, with expectations of minimal inflation. The longer inflation stays low, the less consumers expect rising inflation. The concern among market watchers is that the Fed continues on a rate rise venture, but with inflation proving to be less than expected. This may lead markets to react adversely as rates increase during a dismal growth environment.

The Federal Reserve released favorable results for a stress test on banks, helping propel banking and financial related stocks. The stress tests were initially created during the financial crisis of 2008/2009 in order to minimize risk to banks’ exposure to bad loans and a dire economy. For the first time ever, all banks tested passed the stress tests successfully, building confidence in the sector and future earnings prospects.

It was ten years ago this June that the beginnings of the financial crisis of 2008/2009 started, when two hedge funds managed by the defunct Bear Sterns speculated in credit derivatives and backed by sub-prime mortgage loans and then collapsed.

Sources: Fed, IMF, BLS, Dept. of Commerce

 
The Fed Sets Short Term Rates While The Market Dictates Long Term Rates

Equity Overview – Global Equity Overview

The equity markets started to experience what stock analysts call a sector rotation, when one or several sectors fall out of favor leading to funds flowing to other sectors. This past month technology stocks fell as markets perceived that the sector may have become overvalued. As this occurred, banking and financial sector stocks rose, as favorable regulatory related news lifted the overall sector.

The S&P 500 index posted its strongest first half of the year since 2013. The Dow Jones industrial average index rose 8% in the first half of 2017, it’s best performance since 2013, while the S&P 500 was up 8.2% the first half of 2017. The NASDAQ’s strong performance for the first six months of 2017 was predominantly led by the technology sector, its best first half since 2009.

Global equity markets had the best first annual half since 2009. Overall improving sentiment in the euro zone as well as increasing international growth prospects helped propel global markets the first half of 2017. (Sources: S&P, Reuters, Bloomberg, Dow Jones, Nasdaq)

Flat Yield Curve- Fixed Income Overview

The slope of the yield curve has been flattening in recent weeks, with short-term rates rising faster than longer-bond yields. This typically occurs when monetary policy is tightening. The difference between five-year Treasury notes and 30-year Treasury bonds flattened to 96 basis points in June, the narrowest since December 2007. Five-year note yields, which are highly sensitive to rate policy, rose to a four-week high of 1.80%. Thirty-year bond yields, which are largely driven by future expectations of growth and inflation, meanwhile dropped to 2.72% in mid-June, the lowest since Nov. 9. A key market dynamic are long-term bond prices that are set by the markets, while short-term rates are dictated by the Fed in the form of the Federal Funds rate.

Global government bonds sold off in late June as language from various central banks alluded to the end of monetary stimulus and a start to rate increases. In reaction, government bonds in Europe, the U.S., and Asia fell in price in anticipation of rising yields. (Source: U.S. Treasury, Fed, Bloomberg)

 
The Bull Keeps Running

The Bull Keeps Running

In March 2009, the stock market started its current bull run.  At first, it was a V-shaped bounce from the 2008 Panic lows after mark-to-market accounting was changed.

Next, as the economy recovered, earnings drove stocks higher.  But, between May 19, 2015 and November 3, 2016, the Dow Jones Industrials Average actually fell 2%, while other indices stagnated.  A sharp drop in earnings (due to lower oil prices) and election uncertainty caused angst.

Since then, however, the Dow is up 19% and the tech-heavy NASDAQ is up 22%.  Good policy ideas beget good stock market outcomes.

Last December we set our year-end 2017 stock market targets at 23,750 for the Dow and 2,700 for the S&P 500.

At the time, these targets seemed wildly bullish to many investors.  Now?  Not so much. We need barely more than an 11% increase in each index to hit those targets.

We weren’t counting on better tax, spending and regulatory policy to reach those targets, but if that happens, our targets might be too low!

We use a Capitalized Profits Model (the government’s measure of profits from the GDP reports divided by interest rates) to measure fair value for stocks.  Using a current 10-year Treasury yield of about 2.3% says the S&P 500 is massively undervalued.  We won’t tell you the number because we think the Fed is holding interest rates artificially low.

Using a more rational 10-year yield of 3.5%, fair value for the S&P 500 is 2,700, which is our target.  The model needs a 10-year yield of 3.9% to conclude the S&P 500 is already at fair value, with current profits.

As always, it’s important to recognize we are not market timers and aren’t saying a correction won’t, or can’t, happen.  Corrections come and go.  But market timers get burned time after time.  In other words, if another correction hits in the near future, stay long and buy more.

Late last year we thought the Fed could do four rate hikes in 2017.  It now looks like three.  And with over $2 trillion in excess reserves, the Fed is a very, very long way from creating a tight money environment if and when its starts to unwind QE.

One change to the financial picture is on long-term interest rates.  Six months ago, we thought the 10-year Treasury yield would finish 2017 at 3.25%.  Now we think 3.00%.  That’s a headwind for fixed-income investors, but with growing profits, rising rates are less of a problem for equity holders.

As has been true since 2009, those who stay optimistic will be richly rewarded.  Especially with a better set of fiscal policies.  Stay optimistic and stay invested.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
  

 
What is Cloud Computing?

What is Cloud Computing?

Cloud Computing, simply stated, is the ability to use files and applications over the Internet instead of hosting, storing, or processing them on locally managed hardware.

Thanks to a series of advances in data storage, security, and transmission, individuals and enterprises can now store their data remotely in a third party facility. Because the data and software in use is not physically stored, it’s as though it were floating in a cloud.

You can easily understand cloud computing from the history of personal computer software over the past decade. Ten years ago, a consumer purchasing a new computer would be extremely conscious of the machine’s processing power as well as the size of its random access memory (RAM) and its hard drive. This is because so much of what the consumer might wish to do would take place on the machine and by the machine itself. Any software would be installed onto the computer and accessed by the computer’s central processing unit (CPU) and operating system (OS). The amount of RAM available would determine how fast a program might run, and the total memory on the hard drive would determine what programs one could use.

Today, a corporation, small business, or individual no longer has to make nearly as many decisions when purchasing hardware; in many cases, there are no hardware decisions to make.

As the long-tenured venture capital firm Bessemer Venture Partners summarizes in its Top Ten Laws of Cloud Computing, the headaches that once plagued software providers and users have been relieved. Now, a software provider can bypass these challenges and simply make sure that a business or individual has all the data and applications necessary to succeed.

Some History and Evolution

Cloud computing was more or less created by the growth of consumer Internet. In 1999, there were roughly 50 million broadband users worldwide. In 2012, there were perhaps two billion. As consumers began to have increasing speed and access to the Internet at their leisure, they began to use the consumer web at extraordinary levels.

Then,  Google was born and grew into the behemoth that it is today, tasked with serving the millions and ultimately billions of consumers making trillions or quadrillions of searches. Many of the innovations we see now are a direct result of Google’s response to the Internet’s rapid growth, and many are related to cloud computing. Other consumer web businesses have followed suit. Amazon, for example, became so adept at managing its own data centers and infrastructure that it began offering these skills to third party developers, as Amazon Web Services.

 

 
What is Cloud Computing?

The same transition to cloud infrastructure is now happening in enterprise software. 

Tech firms caught on to this trend and began building similar services solely for enterprises. As a result, businesses no longer need to hire expensive IT consultants or staff to make complicated decisions about hardware or suites of software products. Instead, they have options.

They can make use of “public clouds” such as Dropbox, Box, and Citrix ShareFile, which are used by many other businesses. Or, if they are of sufficient size, they can build their own “private clouds” for security, governance, or other reasons.

As an additional advantage, businesses can keep data in storage owned by a third party, in a data center run by data specialists. This allows businesses to purchase computing and storage almost as they would utilities, on an as-needed basis, which gives them room to scale up or down at will.

As large enterprises continue to adopt cloud computing in all its forms, businesses will have to make critical decisions related to the security, storage, and virtualization of their software, proprietary information, and data. In the future, we expect to see more headlines related to changes in the existing ecosystem and the disruption of key incumbents, like HP and IBM.

What does this mean for VC investing?

The accessibility, utility, and popularity of cloud computing has created an industry shift ripe for disruptive technology innovators. The media continue to pump out headline stories about the role of cloud computing in enterprise software today, as well as the accompanying influx of venture capital in start-ups tackling the space. VCs across investment stages are maintaining a close watch on the sector’s success and growth potential, with the goal of identifying those companies most likely to drive compelling returns for investors. Cloud computing is still a nascent industry, and its potential spans across all industries.

“Software Revolution, Part II: The Shift to Cloud Computing”

Josh Manchester, Forbes Magazine