Market Data for the quarter ending March 31, 2017:
• S&P 500 Stock Index: 2363, up 5.5%
• Ten-year Treasury Note Yield: 2.39%, down .06%
• Gold: $1,251 per ounce, up 8.6%
• Oil: $51 per barrel, down 5.6%
The stock market advanced solidly in the first quarter of 2017 on a strengthening global economy and hopes that “pro-business” policies from President Donald Trump would boost corporate profits. The rally in stocks stalled in the final month of the quarter as doubts surfaced about the ability of President Trump to enact his agenda of lower taxes and increased infrastructure spending. After rising sharply in the fourth quarter of 2016, bond yields stabilized on skepticism that the Trump administration would be able to accelerate economic growth. Similarly, the US dollar weakened as US growth was no longer seen as outperforming the rest of the global economy, as previously thought.
Several risk factors present themselves in the months ahead. First and foremost is the market’s perception of Mr. Trump’s aforementioned ability to enact his pro-business agenda beyond slashing environmental regulations. In their first major legislative test, President Trump and his Republican allies in Congress were unable to “repeal and replace” President Obama’s landmark healthcare reform, the Affordable Care Act. The Republicans had been running on repeal for seven years, and a major campaign promise of President Trump was to quickly repeal and replace the Affordable Care Act with something “much better”. Their inability to execute on a fundamental policy objective draws into question their ability to enact “tax reform”, aka tax cuts, in a meaningful and timely fashion. Furthermore, the final leg of Trump’s economic agenda, infrastructure investment, may be completely out of reach. If they are seen as struggling to move forward on tax cuts, we expect the stock market to come under renewed pressure. A further test of the Republican’s ability to function as a governing party is quickly approaching. The current budget authorization for the Federal government expires on April 29. It is not a foregone conclusion that a “continuing budget resolution” will be agreed upon to avoid a government shutdown. Watch this space.
Politics across the Atlantic also threaten the market. On May 7, France will elect its next president. The likely finalists are centrist candidate Emmanuel Macron and right-wing populist Marine Le Pen. Mr. Macron wants to liberalize the French economy and further integrate France with the European Union, while Ms. Le Pen wants to move the French economy toward greater state control and isolate France from the rest of Europe. Most dangerously, she has threatened, if elected, to remove France from the Eurozone currency block and bring back the French Franc. Such a move could possibly lead to the complete dissolution of the Eurozone and a financial crisis of global proportions. The disruption caused by a disintegration of the Eurozone would be immense given the close financial links among the member economies. If Le Pen wins the election, we would expect an immediate and severe market correction, possibly leading to a full blown bear market if she were to act on removing France from the Euro. Fortunately, Ms. Le Pen’s chances are seen as not good, although after the Brexit vote and the election of Donald Trump, one cannot be too sure.
Finally, a recurring risk has been and remains the fragility of the Chinese economy. In the first months of 2016, the market suffered a strong selloff on fears that the Chinese economy was falling toward recession. Fortunately, Chinese authorities were able to stabilize the economy by heavy use of stimulative measures such as infrastructure investment and loosening the ability of corporations and local governments to obtain credit. The upshot is that Chinese growth is increasingly built upon an ever increasing mountain of debt. As we all learned from the real estate bubble and financial crisis, highly indebted systems are inherently unstable and can collapse like a house of cards when momentum in their growth stalls. China has become the world’s second largest economy, and the financial and economic impacts of a disorderly unwinding of Chinese debt would be significant. The Chinese authorities have been able to keep the music playing thus far. If they were to falter, we would expect the American stock market to suffer a significant correction as was experienced early in 2016.
Fortunately, the risks described above are just that, risks, and far from certain. While they bear close scrutiny and understanding, on a long-term basis, they will ultimately be bumps on the read toward greater portfolio appreciation. This was the case with the recessions and bear markets following the popping of the internet and real estate bubbles, with stocks having recovered to all-time highs. As such, we will continue to execute our strategy of quality, value, diversification, and patience. For the remainder of 2017, we see the US stock market, as represented by the S&P 500 stock index, trading in a range of 2175 to 2500. It closed the first quarter at 2363. We appreciate your business and the confidence you have placed in us. As always, please do not hesitate to contact us with any questions or concerns.