“I can calculate the movement of stars, but not the madness of men”
Sir Isaac Newton
We wrap-up our three-part series on Behavioral Finance in this issue of the Outlook with a discussion of Emotional Biases, which often adversely affect investors’ outcomes. This discussion and the tie-in with Sir Isaac Newton is found in the second half of this quarter’s Outlook.
As we write in early April, the S&P 500 has tacked on year-to-date gains of 4.74% to what has been billed the “Trump Rally”, which began after the November Presidential election. Some may find the market’s staying power surprising given the decidedly “mixed bag” for the new administration’s first eight weeks in office. We say this because in our January Outlook we pinned much of the fourth quarter rally squarely on optimism rather than achievement, as the 45th US President had yet to even be sworn in at the time. Optimism, as measured by equity market levels, has thus far not been displaced by political setbacks, including a failure to roll-back Obamacare, the legal roadblocks to the administration’s immigration orders, or the slow (and as-yet incomplete) approval of cabinet appointments. Regardless of what our clients think of these policies individually, their failure to launch drains the political capital needed to enact policies the capital markets want. We realize the we are in the very early months of the first presidential term, but we think it fair to say the political capital of this administration in finite, and must be used effectively.
We see the economy continuing to grind it out here is the US. The impressive job figures in January and February were theorized by some that not only did optimism permeate Wall Street, but that hiring was being positively affected by managers and business owners who anticipated regulatory reforms and corporate tax cuts. So went the narrative, until the less than impressive March non-farm payroll figures (98,000 new jobs created vs. expectations of 180,000), and a 38,000-combined downward revision to February and January payroll gains has called this theory into question. And yet, the market’s response has been muted.
Additional pressure on the market could have also been expected by the Federal Reserve’s 25 basis point interest rate hike in March, which, on the heels of the December rate hike was the first back-to-back interest rate increase in eleven years. The fed has also indicated in transparent language that they expect to raise rates twice more in 2017. And yet, the market’s response has been muted.
CCR Wealth Management’s outlook is bifurcated into nearer-term probabilities, and longer term expectations. In the near term, we think it is important to remind our clients that market corrections are a normal occurrence, and indeed occasional corrections may help fuel longer-term market expansions through a process of depressurization. We resurrect this by now (hopefully) familiar chart to make this point. An average intra-year drop in equity prices of 14.1% has still produced positive annual equity market returns over 75% of the time over nearly 40 years. As we know, market corrections often develop quickly. What would a 14% correction in the Dow Jones Industrial Average look like today? Answer; a drop of nearly 3000 points! Our message is don’t panic—but know something similar could be coming. It has been over a year since the last 10%+ correction in equity markets.
While equity markets have remained stalwart year-to-date, in the short term we have seen some technical indicators developing which may infer investors are hedging their optimism. Gold prices have risen nearly 14% off their December low’s, and the ten-year treasury yield has fallen about 15% at this writing, and is at levels last seen in mid-November (a drop in yields indicates a rise in prices). Both Gold and Treasury bond values often have a negative correlation to equity and credit risk in times of volatility. In short, we think many market participants are hedging in the near-term against a return of market volatility, and the probability of a bumpier ride in the near term has increased. While forecasting short-term market gyrations is difficult, we again point to a rally built on little more than optimism. A possible source of nearer term volatility the attempt at tax-reform legislation. Tax reform looms large in the near-term as the next test of the new administration’s ability to enact campaign pledges—most of which to-date remain unfulfilled by a government dominated by one political party. Tax reform is also highly anticipated by investors and corporate America. A fate similar to the healthcare attempt almost certainly will invite back volatility.