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.
By most measures the equity markets are at the high end of the valuation spectrum. While this does not mean that a large sell off is eminent, it does suggest that upside potential is limited at these levels. We shifted to a more conservative stance last summer and we remain cautious today. The current bull market, one of the longest since World War Two, is getting old and is showing signs of a late cycle bull market. While we can never predict short term market moves, we believe this conservative stance is appropriate.
We are also cautious in our outlook for the bond market. Interest rates have been so low over the past few years that even a moderate increase in rates would cause a fairly substantial selloff in bond prices. We will be watching the inflation numbers very closely this year and adjusting our bond portfolios accordingly. While we believe inflation may pick up to some degree we do not believe it will reach high levels.
All in all, the U.S. and world economies are still expanding, and that is good for equity markets. In an expansion as old as this one, however, markets tend to get overextended and expensive relative to earnings, which is where we find ourselves right now. We feel the longer-term bull market remains intact, so if there is a selloff in stocks we would be buyers. We will keep you posted as our thoughts change, but in the meantime, please feel free to call us if you would like more details on our investment thoughts or if you would like to review your portfolio.
About Wabash Capital
Wabash Capital is an employee-owned registered investment advisor based in Terre Haute, Indiana, providing investment advice and professional portfolio management to individuals, corporations, banks, trusts, retirement plans and endowments. To learn more about our business, please visit www.wabashcapital.com.