“The beat goes on, the beat goes on. Drums keep pounding rhythm to the brain. La de da de de, la de da de da.” Those lyrics were written by Sonny Bono and sung by Sonny and Cher in 1967. I was only five years old then; my young parents were only 26. This record was in our house and my mind from a very young age. With the commercial and TV success of Sonny and Cher before their split in the seventies, this song has become part of the soundtrack of my life and that of many other baby boomers. Nice little anecdote, but what does it have to do with the financial markets? Let me get to the point, financially speaking.
Despite warnings that the stock market is suffering from propped up valuations caused by excessive quantitative easing by global central banks, and in the face of global strife and continued terrorism, the stock market just keeps grinding higher. As investors, this should make us happy and I think we are all enjoying the increases in our net worth. However, it has been more than eight years since the stock market bottomed after the financial crisis. This is an unusually long time for the stock market not to have a 20% correction. These corrections typically happen about every three years. Yet, sometimes we are blessed with extended periods of financial and economic bliss. Perhaps this is one of those times. Will this rally in stocks continue much longer?
For the record, at the mid-point of 2017, here is where the market stands. The two popular large-cap stocks indices, the Dow Industrials and the S&P 500, are tracking each other closely. They are up 8.0% and 8.2%, respectively. The mid-cap and small-cap indices have been a little weaker, possibly taking a breather from strong gains in 2016. The S&P 400 Mid-Cap Index is up 5.2%, while the Russell 2000 Small-Cap Index is up 4.3%. The best performing broad market stock index this year is the global developed country index, the Morgan Stanley EAFE Index. International stocks, which have been lagging US stock returns for years, are poised to “catch up” and have finally started to outperform. For the first half of the year, the MSCI EAFE Index is up 14.4%. Our typical balanced account has maintained an exposure to international stocks for years and our patience is being rewarded in 2017.
The fixed income markets have not been as smooth and steady as the stock markets this year. For those into the daily minutiae of fixed income markets, they have been exciting and volatile in their own way. We have had two Fed rate hikes this year with forecasts for at least one more by year end. We have seen the 10-year US Treasury note vacillate between inflation forecasting and recession forecasting in the past six months. However, just looking at the mid-year snapshot of the most widely used composite bond index, the Bloomberg Barclays US Aggregate, it shows that bonds have returned 2.3% at the midpoint of 2017, a modest move from the start of the year.
On the positive side for stocks: earnings are improving, regulation is decreasing and general economic growth, though subpar, is steady for the time being. The current US government gridlock is probably bad for a social agenda, but positive for a business agenda. Historically, stocks have thrived when political gridlock prevails. Companies, like people, typically do not like change. Gridlock keeps change from happening and allows businesses to plan for what they know versus preparing for the unknown. I could spend some time listing all the potential negatives, but for now the stock market just does not care; the beat goes on. However, I have my ear to the ground and after 30 years of experience, I am listening very carefully for the definitive words of caution: “It’s different this time.” Whenever any semi-prominent market forecaster starts to explain the markets’ extended good fortune is due to structural changes in valuation parameters that make things “different this time” and, therefore, immune to the risks of the past, that will be the signal to get conservative! Until then, la de da de de, la de da de da.
Mike Kauffelt, CFA
Bill Few Associates, Inc.
All data from Bloomberg, Factset and The Wall Street Journal
*In April, we promoted Thomas Beilstein to Co-CIO (Chief Investment Officer) at BFA. Tom’s extensive experience, CFA designation and 20-plus years of investment service to BFA made him qualified to assume this post. Future updates may be authored by Tom directly, although I liberally borrow from all our investment staff: Thomas Beilstein, Tammy Vargo and Andrew Demosthenous when compiling these updates. Of course, any errors are mine and most insights belong to them.