The stock market stormed out of the gate during the first two months of 2017 as hopes regarding fewer business regulations and increased consumer confidence fueled investor’s optimism for equities. The bond market was flat during the first quarter as increased inflation expectations and higher interest rates were a drag on bond prices.
The Federal Reserve raised interest rates during the first quarter for the first of what is expected to be multiple rate increases during this year. The economy continued the expansion that has been underway since 2009, allowing the Fed the ability to hike rates. Most analysts are projecting a pickup in inflation over the next two years and this is the primary catalyst for increasing interest rates. Another factor is the very low unemployment rate, which can be inflationary with a growing economy. As we have said before, the Fed has the very difficult job of keeping the economy growing but preventing it from growing so fast we have high inflation. This can be a difficult job to manage.
The current economic expansion is the third longest since the end of World War II and is showing signs of age. Business spending is slowing, earnings multiples are high, profits are weakening as a percentage of GDP, short term interest rates are rising, and M&A activity is increasing. These are all late business cycle events. While we do not believe that an economic recession is eminent, there are certainly warning signs out there.
The bond market has dropped considerably since the election. In the five weeks after the election, the value of a 10-year Treasury note dropped by 26%. Back in July, the yield on a 10-year Treasury note hit 1.36%, the lowest yield ever, and 10 year Treasuries have been trading for 226 years. Currently, the yield on the same bond is over 2.5%. It is obviously difficult to trade in this type of market and extreme volatility. While interest rates have moved up, we believe rates will stay relatively low.
For the record, the best trading day of the year for stocks was +2.5%, back in January. The worst trading day of the year was -3.6%, back in June. Overall, it was not a very eventful year for stocks, the late rally notwithstanding. Valuations have risen to high levels, which is typical for this stage of the business cycle. While we cannot accurately predict short term stock market performance, we continue to believe that upside potential is limited at these levels and have taken a cautious stance with stocks. We shifted to more conservative portfolios earlier this year, and if stocks move much higher from current levels, we are nearing the point where another shift is warranted. Always remember that successful stock investing requires selling when stocks rise, and buying when stocks drop. While we are cautious in the short term, we believe the longer-term bull market in stocks remains intact, and would be stock buyers if there is a pullback in the market.
If you would like an updated copy of our Form ADV, which is on file with the SEC, please contact us or go to our website. This form will be updated in early 2017, as it is every year. We encourage you to review this as it has lots of information about Wabash Capital and our officers. We truly appreciate your business and please feel free to contact us if you need anything.