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Independence

It’s July 4th, 2017, 241 years from the day the Continental Congress adopted the Declaration of Independence, declaring the 13 American colonies to be independent from Great Britain.   For me, I cannot believe both the bravery and the foresight of the men who crafted the Declaration, the Constitution and the Bill of Rights.  So many things could have turned out differently, and yet, here we are, celebrating our independence.   

This year, stock investors can also celebrate what has been an exceptional first half of the year.  Returns to stocks, measured by the S&P 500, have produced a healthy total return of 9.34%.  One prominent aspect of the stock market this year has been the tail-wind for growth stocks, as opposed to value stocks.  This plays to our strength as we have been steadfast growth at a reasonable price investors for years.

Year to date, the technology sector has produced returns nearly double the next best sector, an impressive run.  Prices wavered some in late June, but I expect their leadership to continue.  The sharp end of the technology stick is referred to as FAANG (Facebook, Apple, Amazon, Netflix and Google/Alphabet) – and all have shown sensational returns this year.  Other pockets of strength include financials, where the banks are benefitting from favorable capital requirements, spurred by the heads of the European and US Central banks.  We have also seen attractive returns from healthcare stocks, likely indicating the market anticipates a more favorable business environment.  Bringing up the rear is energy.  In my lay opinion, there is simply too much oil out there, and demand looks suspect. 

On the economic front, growth is ok, but not by much.  Q1 2017 GDP came in at 1.2% annual growth, following a 2.1% reading for 4Q 2016.  My tarot cards do not include an inflation card.  It’s the equivalent of a child’s monster under the bed – scary but not there.  The Federal Reserve is staying with its script, raising rates and unwinding its balance sheet (tightening).  There are plusses and minuses that do not add up.  Energy prices are low, pleasing at the pump but bad for igniting capital spending.  The dollar is low.  This may boost exports, but conversely may raise prices on imported goods.  I am not convinced we will see strong enough economic data to support a steepening in the yield curve.

The market has shown a high degree of complacency since the election.  This will change, eventually.  There is the idea that great athletes have a high tolerance for physical discomfort.  I’m curious if that is a common characteristic for great investors too.  Can they remain even handed in a highly discomforting environment?  And for how long?  An observation of our current society is how uncomfortable with discomfort people are.  When something unpleasant arises, there is often a need to immediately re-direct, to take some medication, or do something to put the discomfort to rest.

Until the complacency lifts, we have a reasonable backdrop: the economy is standing on its own two feet and earnings growth is in the low double digits.  This “just so” scenario is allowing stock prices to rise.  The market seems to have given up any expectation of anything constructive from Washington DC.  In fact, the opposite may be true at this point.  If Washington DC does in fact do something, other than tweet, it may serve to disrupt what has become an acceptable status quo.  There is a watch what you wish for aspect to our current situation.

Looking ahead, my expectation is for the stock market to mark time, and then show some strength later in the year and into 2018.  I am optimistic on the earnings front and believe this will support stock valuations. I do not think we will see a substantive rise in interest rates, and therefore, I am neutral on tax free and corporate bond markets. I think they are relatively safe, and returns will be mediocre. Obviously, if any of these factors change, my opinion as to how best to invest will change and I will relay that to you. In the meantime, please have a peaceful Fourth of July and if you think of it, take a moment to pause and reflect on the amazing movement that began here in Philadelphia, all those years ago.

Bruce Hotaling, CFA

Managing Partner

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