Second Quarter 2017 Review & Outlook – Game Plan for a Market Hangover

Post-Election Celebration

The first quarter picked up where the fourth quarter left off, with equity markets celebrating the surprise of a new U.S. administration that global investors perceived to be more business friendly than the previous one. During the quarter, stocks rallied around the world and along with a pullback in the U.S. dollar and signs that global growth was slowly reviving, many international stocks enjoyed gains in excess of the U.S. While the stock market roared, the bond and commodity markets were less enthused, as bonds bounced and commodities gave back some of the gains that accrued towards the end of the year. By the end of the quarter the equity markets were mostly calm, but with tensions that were beginning to build and signal that some of the election-driven luster was beginning to wear off.

Has the Hangover Arrived?

Last quarter we surmised that the results of the U.S. election provided a roadmap to help guide investments over the next few years, mostly based on potential future policy changes. The roadmap was based on three major forces that we believe will drive markets, sectors, and asset classes over a multi-year period: the likelihood for some degree of fiscal stimulus, deregulation, and protectionism. This thesis was constructed around the idea that these forces should act as a positive catalyst, but also included the caution that recent market euphoria might bring about a market hangover in 2017, as lofty expectations were primed to produce short-term disappointment as it became clearer that making major policy changes in the current political climate would be more challenging than advertised.

Admittedly, recent market strength held in a bit longer than anticipated during much of the first quarter, but recent activity suggests that a market hangover may now be unfolding. While the major U.S. indices have held firm, a variety of other markets have not been in sync with equities. Bond prices have drifted higher, defensive stocks have been outperforming their cyclical counterparts, and safe havens like gold and the Japanese yen have shown strength over the last few months. None of these market movements ensure that stocks will decline more meaningfully, but enough evidence is accumulating to suggest that an overdue correction may be approaching.

Game Plan for a Market Hangover

Market corrections never feel good as they are occurring, but they shouldn’t be viewed as a calamitous event, either. The truth is that after more than 200 days without even a 5% correction in U.S. stocks, the major indices might be ripe for a healthy cleansing of some of the momentum buyers who jumped on board over the last few quarters. It’s impossible to know how far a correction might carry once it starts, but considering that most of the broader evidence we follow is not signaling that a bear market is on the horizon, our current intent is to use any corrective activity to further align portfolio positioning with the areas of the market that should benefit from the catalysts previously mentioned.

Candidates to Build Into

The forces of fiscal stimulus, deregulation, and protectionism are leading the way in pointing to those areas that appear attractive to build into. Some of those areas are: