The second quarter continued the stock market rally that began last fall. Over the past year, the S&P 500 has gained an impressive 17.9%. International stocks have also enjoyed a significant rise with the MSCI EAFE gaining 20.3% and the MSCI Emerging Markets Index rising 23.8%. Much of the rally has been fueled by investor and business optimism, but the global economy has also improved quite a bit over the past year, and in a synchronized fashion.
After more than eight years of a bull market, there are concerns among some investors about the length of the market rally and the high valuations in the stock market. Although there have been corrections along the way, the current market rally, which began in March of 2009, is one of the longest on record. The current price/earning ratio for the S&P 500, based on expected earnings, is 17.5x. This is slightly higher than the 25-year average of 16.0x. However, given the low inflation and interest rate environment, many still believe there is room for the rally to continue.
So far this year, the market has been uncharacteristically steady. The resilience of the market in the face of political uncertainty, rising geopolitical risks, and tightening Fed policy has earned it the moniker of the “Teflon market.” Following June’s 0.6% rise in the S&P 500, we have now enjoyed eight consecutive months of positive returns, which is the first time this has happened in six years. Volatility, as measured by the VIX index has also remained well below its long-term average for nearly two years.
The Fed has recently implemented three interest rate hikes, with the first occurring last December. The Fed is also beginning to contemplate ways to reduce their balance sheet. Unlike in recent years, the market reaction to the latest Fed actions has been mostly non-existent. Since the financial crisis, and unprecedented monetary response by the central bank, the market has been very sensitive to the Fed’s comments and actions. But in a major shift, the market’s focus has moved away from the Fed, focusing more on other global central banks, most notably, the Bank of England and the European Central Bank. There has also been more attention on economic developments, both here and abroad.
With central banks beginning to tighten their monetary policies, and a corresponding rise in short-term interest rates, it has been a volatile period for government bonds, with the Barclay’s Aggregate Bond Index declining –0.3% over the past year. As many have predicted, rising rates have created a headwind for long-term government bonds, which is causing many investors to shift towards shorter-maturity bonds.
After several years of steady, high oil prices, oil experienced a major crash in 2014, falling from a high of over $100 per barrel to a low in early 2016 of $31. This had a significant, negative impact on the profits and stock prices of energy companies. Since then, oil has slowly regained its footing and risen to a much more comfortable (and profitable) mid-$50 level. But in an echo to the previous slide, oil has unexpectedly fallen 20% this year on fresh concerns of oversupply. In recent sessions, the price has firmed again, and hope remains that they oil will settle back into a less volatile (and more profitable) range.
Following the election last fall, politics have come sharply into focus. More specifically, investors are interested in policy reforms that could create a more pro-business environment. There has been much debate over healthcare reform, and there is a great deal of attention being paid to possible income tax reforms. Investors are hoping for more competitive tax rates for businesses, and relief for individual taxpayers. So far, there hasn’t been much movement for either healthcare or tax reforms, but President Trump has followed through with some of his promises to relax regulations, giving life to the hope that more business-friendly policy reforms will follow. For meaningful policy changes to occur, it is looking more likely that Republicans and Democrats will need to work together to find bi-partisan solutions.
The U.S. economy has entered its 96th month of expansion, more than twice as long as the historical average of 47 months. Although the pace of the expansion remains soft, many think the steady and measured growth has been a significant contributor to the long duration. Recent economic readings have continued the positive trend. Real GDP growth came in at 2.1% for the first quarter, and unemployment has fallen to 4.4% from a recession high of 10.0% in 2009. In many important areas of the economy, there are clear and positive signals of ongoing strength in our economy.
Following a multi-year expansion, we believe that synchronized growth in the global economy and corporate profits will continue for the foreseeable future. Despite concerns that the market has become somewhat overvalued, we remain hopeful that continued economic growth and investor optimism will lead to further positive market returns in the coming quarters.
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Horizon Advisors is a Houston based fee-only wealth management firm. Horizon specializes in helping successful individuals and families understand, organize, and manage their often complex financial situations. Horizon offers integrated financial planning and investment management services.