Market Data for the quarter ending June 30, 2017:
• S&P 500 Stock Index: 2423, up 2.5%
• Ten-year Treasury Note Yield: 2.30%, down .09%
• Gold: $1,242 per ounce, down .07%
• Oil: $46 per barrel, down 9.8%
Stocks rallied, and bond yields declined in the second quarter of 2017 as strong earnings growth, solid global economic performance, and modest inflation buoyed financial markets. Decreased political uncertainty in Europe also played a positive role, as the moderate Emanuel Macron defeated right-wing populist Marine Le Pen in the French presidential election. Strength in global economies weakened the dollar, boosting corporate profits, while fears of continued oversupply sunk oil prices. The market saw record setting low volatility in the second quarter with the benign conditions described above, although volatility did pickup in the final week of the quarter with fears of tighter monetary policy increasing gyrations in stocks, bonds, and currencies. We will elaborate further on this below along with other risks to financial markets.
The above mentioned fears of tighter monetary policy do represent a legitimate threat to stocks and the global economy. Following the financial crisis of 2008-09, global central banks dramatically increased monetary accommodation by slashing short-term interest rates and buying large quantities of long-term bonds, thus flooding the financial system with money. This loosening of financial conditions played a vital role in driving stocks higher while supporting economic growth. However, recent statements from the heads of the US Federal Reserve, European Central Bank, and the Bank of England suggest that this era of easy money may be coming to an end. The Federal Reserve has already raised the overnight interest rate charged by banks by a full percentage point in the last eighteen months. We feel a tightening of monetary conditions is premature given persistently weak inflation and a global economy that although firming, is far from overheating. If central banks misjudge conditions and aggressively remove monetary accommodation, global economies would be at a heightened risk of recession with consequent negative implications for stocks.
As we discussed in our previous market analysis, the Chinese financial system represents a further risk to the global economy and world stock markets. Simply put, growth in the Chinese economy is increasingly dependent upon debt, which is an inherently unstable condition. As was the case with the real estate driven financial crisis in the US, if economic momentum is not maintained, a highly indebted financial system can collapse like a house of cards. Although Chinese authorities have thus far been able to keep the Chinese economy on track, continued success is far from assured. If the Chinese financial system were to seize up, the implications for global economic growth would be significant as would the impact on world stock markets. Previous bouts of Chinese financial instability in the summer of 2015 and early 2016 saw sharp declines in global and US stock markets.
The final risk is perhaps the most significant. The possibility of war on the Korean peninsula due to the situation surrounding North Korea’s development of nuclear weapons and intercontinental ballistic missiles (ICBMs) capable of striking America is very real, although the odds are exceedingly difficult to handicap. A war with North Korea would be devastating both in terms of the loss in human life and the impact on the world economy and global financial markets. The sheer magnitude of death and destruction may, hopefully, be enough to dissuade the parties involved to refrain from hostilities. However, the leadership of North Korea views the development of nuclear armed ICBMs as essential to its long-term survival, while President Trump has shown himself at times to be impulsive and erratic. This is a highly combustible situation. If the US is seen as dramatically increasing the aggressiveness of its rhetoric and military capabilities in the region, we would expect significant declines in world and US stock markets.
Absent the realization of the risks detailed above, we expect the US stock market to continue to rally for the remainder of the year. Global growth and corporate profits have real momentum and should support higher share prices. We do not desire to seem overly pessimistic in describing the risks to the markets. They are far from certain. However, it is important to always be cognizant of risk. Understanding market drivers is the key to maintaining investment stability and avoiding panic, which is never a sound strategy. In the face of uncertainty, which in truth is always present, we will continue to execute our own strategy of quality, value, patience, and diversification. For the remainder of 2017, we expect the market, as represented by The Standard and Poor’s Five-hundred stock index to trade in a range of 2250 to 2550. It closed the second quarter at 2423. We thank you for the continued confidence you have placed in us, and as always, please do not hesitate to contact us to discuss questions or concerns.