Monthly Outlook: March 2017
Equity markets have floated steadily higher since the U.S. presidential elections four months ago. While this has surprised about half of the people, it shouldn’t come as too big of a surprise that promises of tax cuts, de‐regulation, and fiscal stimulus are sweet music to investors’ ears. But as last night’s state of the union address made clear, there are precious few details to suggest that any of these promised changes will happen quickly. While the exuberance can continue without details, at some point investors are likely to pause and reconsider the facts. While a small pullback in stock prices is likely, we are far from any major sell signal or reversal of the current uptrend. That’s the state of the markets as we enter into March.
February was another good month for us. Our growth assets provided above average returns. U.S. stocks (Russell 1000) gained a solid 3.8% and international stocks (FTSE All‐world ex USA) gained 1.2%. Commodities were flat as a group but REITs were 3.5% higher. Stability assets were solid, but boring. Intermediate term bonds (Barclays Aggregate) added just 0.6% for February. Depending on your allocation, you’ll have a mix of these growth and stability assets. Although the growth assets have been outperforming these past four months and stability assets appear to be a boring anchor, it’s important to remember that it can reverse. The growth assets are volatile and if they have a down month, the stability assets typically come to the rescue. That’s the point of diversification. Maybe March will make that point, we’ll see.
Stand and Deliver
As the first 100 days of the presidential honeymoon starts to fade, investors are likely to expect the new administration to deliver. We suspect that the harsh reality is that policy changes are complex and just take time, maybe quite a bit of time. This is true for any political party. On top of this, the Federal Reserve, led by Janet Yellen, is signaling that they are more likely to raise interest rates a couple of times this year to catch up to the recovered economy. The likelihood of a March rate hike has now shot up to > 70%. Will Yellen take away the punch bowl at the stock market party with a rate hike on March 15th? Will that be enough for equity investors to at least pause and reconsider their extended positions? Probably, but it’s likely to only be a pause or a pullback for now. Markets have a very long history of zigs and zags within their trends. They can trend higher for years but have many 3% to 5% pullbacks along the way, every few months or so. We haven’t had a pullback since the election, some four months ago so one is likely soon. It’s interesting to note that a 4% pullback would put the S&P500 back where it was in December. That may not sound true, but it is. We think it’s better to put any remaining cash to work on such a likely pullback in the weeks ahead.
Valuations Don’t Matter
We’ve been reminding our readers that stock market valuations have been high for quite some time, over a year in fact. So what, right? In the short term, valuations don’t matter, but in the long term they’ve been important indicators of major tops and bottoms. We look at valuation metrics like TMC/GDP, P/E10, Margin Debt, and ValueLine MAP. They remain extremely high, similar to tops of 2007, 2000, and even 1928. BUT…the stock market trends remain up and so we stay invested. We only use the valuations to remind ourselves that when the trend changes – next month or next year – that we will need to sell and move to protection mode. We share these valuation levels with you to let you know we’re aware of them, aware of the risk, and are watching carefully.
Always and Never
Given the strong rally these last four months, it’s tempting to think the market is always going to move higher. I remember in 2008, during the last crash, the comments that markets would never come back. Let’s take the long view and remember to stay flexible, invest with the trends, and not project into the future the most recent zigs and zags. We use a disciplined strategy to grow most of the time, and protect when needed. The key is to not get distracted from that goal.