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Better Times Ahead April 15, 2014
As we in the northern hemisphere begin to thaw out from the polar vortex winter, the U.S. economy is gaining strength. Confidence is improving as incomes have increased with gains in employment leading to stronger consumer spending. GDP grew at just 1.9% in 2013, but is expected to be in the neighborhood of 3.0% in the current quarter. The economy is rebounding from the fiscal drag last year when taxes were increased and spending was cut. The housing market is showing signs of strength with home prices rising and mortgage rates remaining low leading to further increases in new construction. The prospects for corporate investment spending are favorable considering strong balance sheets and high cash positions.
The worst may be over for countries in the Euro zone, and, according to the IMF, the global economy is turning the corner from the Great Recession. However, the global recovery remains vulnerable to changes in the Chinese economy where GDP growth has slowed from a 10.5% rate to 7.5% annually. As a result, it has been reported that export growth from developed countries to China has slowed sharply in recent months and that the manufacturing sector has been struggling in other emerging countries.
Much attention has been given to Federal Reserve monetary policy since Janet Yellen was named chair to succeed Ben Bernanke. The first meeting she chaired in March and the press conference following created more ambiguity than clarity on the timing of the first Fed Funds rate rise. The minutes of the meeting said that the “FOMC statement does not indicate any change to the committee policy intentions,” but her comments suggested that the first Fed Funds rate increase could be earlier than had been generally expected. The Fed has dropped its 6.5% unemployment rate threshold as an indicator for when rates might be raised and has replaced it with the “Yellen Dashboard” which has a broad range of economic indicators. Beyond monetary actions, higher rates could reflect the stronger growth in the U.S. economy, improvement in employment and a somewhat higher inflation rate from the present core CPI of 1.8%. Even so, at current growth rates and with continued moderation in inflation, interest rates are expected to be range-bound in the next year.
Risk management has become increasingly challenging with traditional low risk investments, like bonds, offering little return potential. After last year’s negative performance in most fixed income securities, cash flows have been coming out of bond funds and moving back into equities, even as bond investments have outperformed most other investments so far in 2014.
Bond investing is not as safe and secure as it once was. With interest rates as low as they are now, income return is low, principal values will be eroded by inflation and bonds are vulnerable to principal price risk as interest rates rise prior to maturity.
Strategic asset allocation for investment portfolios is driven by consultation with clients to achieve their objectives and cash flow needs while taking into consideration their tolerance for short-term volatility. The discipline of sticking to a long-term investment strategy offers better prospects than trying to guess the next move in the market. The shift by investors to increase their allocation to equities back to more normal levels is just beginning, but will be tested from time-to-time with short-term declines in stock prices.
Equities have rewarded investors with exceptional returns over the last five years as the economy has recovered from the great recession and financial crisis. While the rise in stock prices most recently has been driven mostly by rising valuations, the U.S. economy is well-positioned to continue its growth and profitability. There are still good investment opportunities in higher-quality large-cap stocks for investors who can live with market volatility.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.