July 2017 Market Commentary

“An investment in knowledge always pays the best interest”
(Benjamin Franklin)

“Ain’t No Cure for the Summertime Blues”

“I'm gonna raise a fuss, I'm gonna raise a holler
About a-workin' all summer just to try to earn a dollar
Every time I call my baby, try to get a date
My boss says, ‘No dice son, you gotta work late’
Sometimes I wonder what I'm a-gonna do
But there ain't no cure for the summertime blues” (“Summertime Blues”, by Eddie Cochran)

It is stinking hot and steamy on the East Coast these days, as the proverbial “dog days of summer” set in. Historically, this was a time of year when things slowed down, people went on vacation, and it was generally too hot to move fast, but not this year. The Trump administration keeps bungling its agenda and can’t / won’t move on from the “nothing to see here, folks, but let’s keep looking” Russia imbroglio. The market shrugs off signs of decelerating economic growth and inflation and just keeps hitting new highs. P/E ratios keep expanding as stock price growth outpaces earnings and economic growth.

We are at valuation levels that have been exceeded only 3-4 times in history (all of which were followed by catastrophic market downturns), and no one seems to care. While we are not hearing the clichéd “this time it’s different” sonata, investors are behaving as if, somehow, this time it’s different.

Partly this is due to respectable earnings growth and a low interest (discount) rate environment – companies actually are doing better and the global economy is, in fact, improving (albeit slowly). Partly it is also due to the “TINA” (“There Is No Alternative”) effect – rates are low and credit spreads are tight and, if anything, the public fixed income market looks even more expensive than the stock market (and that’s saying something). Anyone hoping for any level of return needs to invest in stocks.

Market complacency is the order of the day – volatility is trading routinely below 10%, and we have not had a 5% correction in over a year – the longest rally streak since 1995. But, as economist Herbert Stein noted, “If something cannot go on forever, it will stop”.

Put differently, this market will correct – valuations simply are too high for it not to. The economy is chugging along, earnings are solid (although expected to stabilize), and interest rates are likely to remain “lower for longer”. So the market may continue to rise, for a while. But as it begins to price in slower growth, as the Trump agenda stalls, we think the summertime blues may be followed by a winter of our discontent – we will be (gladly) surprised if volatility does not increase and the market does not correct as summer vacations end and we head into Q4 of this year.

Enjoy the beach, lake, mountain, or your own backyard. Catch up on your reading and with your family. This coming fall, we are likely to see more than just a change in the weather.

With that as a backdrop, looking out over the current economic and investment landscapes, here is what we see.

The Current Economic & Market Landscape

  • The global economy remains relatively benign right now:
  • US Q1 2017 GDP was revised up slightly to 1.4%; the initial estimate for Q2 is 2.7% (which is likely to fall with future estimates); and the estimate for all of 2017 is 2.3% (source: The Wall Street Journal);
  • Inflation is decelerating – causing some Fed concern;
  • Wages continue to grow slower than employment levels – the tangible consequence of automation and globalization;
  • The Eurozone Q1 2017 GDP growth is estimated at 0.6%; and roughly 2.0% for all of 2017 (source: TradingEconomics) – it is gaining momentum, especially manufacturing; on the flip side, as in the US, inflation seems to be decelerating, which will cause anxiety regarding policy maneuvers by the ECB;
  • GDP and manufacturing are expanding slowly across most countries;
  • There are growing concerns over a “hard” “Brexit”;
  • Unemployment is falling overall, but it varies widely from country to country;
  • Japan’s GDP was a positive 0.3% in Q1, the fifth straight quarter of positive growth. After weakening dramatically post-election, the yen has strengthened again over the past 2-3 months, hurting exports;
  • China’s (official) growth rate is stable at roughly 6.9%, but debt build up, real estate prices, and capital flow controls suggest some underlying fragility;