Both Stocks and Bonds Resilient
Since the end of the first quarter on March 31, U.S. stocks have made good progress. The S&P 500 Index is 1.6% higher than on that date and is trading just a whisker off of its all-time highs as I write this. Since that time, first quarter corporate earnings have (mostly) been reported and investors largely liked the numbers. The sectors leading the markets have changed in recent months, however. While it was the financial and industrial sectors that performed the best in the immediate aftermath of the election, technology has come back to become the driving force in the markets after sitting out the rally in late 2016.
Bonds, which lost ground after the election as investors positioned for a higher-growth, higher-inflation environment, have been making back some of that ground so far in the second quarter. The ten-year U.S. Treasury note yield has fallen from 2.39% on March 31 to 2.27% today. (As yields fall, bond prices appreciate.) While 12 basis points is not a huge move, it does signal that investors are becoming somewhat more circumspect about the prospect of accelerating economic growth as we enter the back half of 2017. In that sense these yields are something of a barometer of the progress of the new administration. As investors foresee delays or major changes to the administration’s stated agenda, they are more likely to be adding to their bond positions, pushing prices higher. The mostly stable yields on longer-term Treasury debt despite the two recent Fed rate hikes show that investors are not yet convinced that the economy can rev up to the administration’s 3% growth target anytime soon.
Economic Growth Anemic
While both the equity and fixed income markets have done fine so far in 2017, the economy overall is dragging. First quarter economic growth in the U.S. was a mere 0.7%, the weakest pace of growth in three years. Consumer spending just barely grew and corporations invested less on replenishing their inventories. This 0.7% performance came on the heels of 2.1% growth in the fourth quarter of 2016.
Two Strong Countervailing Forces
Today investors are still in wait-and-see mode as they closely watch two main issues—one of which seems to be holding stocks back and one that seems to be trying to propel them higher. The issue that seems to be impeding stocks is the progress of the Trump administration on its legislative agenda. The focus in Congress seems to have shifted in recent weeks from legislative matters such as health care and tax reform to the ongoing investigation into the alleged ties between members of the Trump campaign and Russia. To the extent that this investigation bogs down the administration as we go into the summer, investors will come to see major changes on the tax reform front as less likely to occur in 2017. If the administration were to formally push out its timeline for passage and implementation of its proposed reforms, many investors will be likely be disappointed.
On the bright side, U.S. companies continue to do quite well on the profit front. Outside of the consumer sector, they (mostly) reported strong earnings growth in the first quarter, despite the meager gross domestic product (GDP) growth in the quarter. Because many companies have become more efficient and repurchased many of their own shares over recent years, they are not dependent on a strong economy to boost their earnings. It is not intuitive, but investors should remember that stocks do not require a backdrop of rapid economic growth to deliver attractive investment returns.
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