Perspectives

Q1 2017: Is a New Wind Blowing?

Prepared by Zach Ivey

Looking back over this first quarter of the year, it is hard not to think about how different things are this year compared to the start of 2016, when stock markets had a rough start and investor sentiment was pretty low. Emotions ran high around the election and we suggested remaining calm, looking at the fundamentals in the economy, and sticking to your investment plan (Making Sense of Election Results). Since the election, the U.S. market has traded up seemingly on expectations of tax reform, infrastructure spending, deregulation, and healthcare reform. This optimism appears to have spread beyond our borders and positive signs abroad have pushed up foreign stock markets as well. It is important to recognize that markets tend to be forward looking and prices are based on these future predictions about profits/interest rates/inflation. When multiple variables have the potential to change all at once (such as policies on taxes, regulation, government spending, etc.), markets can change very quickly.

Q1 2017

Source:  BlackRock Benchmark Returns Comparison March 2017/Bloomberg

U.S. Stocks

The S&P 500 jumped 5% after the election to close out 2016 and the rally continued into 2017, up an additional 6.07% in this first quarter.  Looking back at last year (2016: A Year in Review), the stocks that led the pack in the S&P 500 were the value-oriented stocks represented by energy, industrials, utilities, and telecom stocks.  Market leadership has shifted in 2017 with growth-oriented sectors like consumer discretionary, healthcare, and technology leading the market.  Small U.S. companies had a tremendous year last year, ending the year up 26.56%, apparently on hopes of deregulation and tax reform, but are only up 2.47% at the end of the first quarter.  These outperformance-followed-by-underperformance situations are somewhat common in the market and should be considered to be more the norm than the exception.  If one area of the market does really well or really poorly, oftentimes the pendulum swings a bit too far and corrects itself at some point in the near future.  

International Stocks

For the first time since 2012, developed international stocks (represented by the EAFE Index) have outperformed the S&P 500, returning 7.25% in the first quarter.  This market movement has occurred in response to improving economic fundamentals in most every country around the world (excluding only Greece and Korea).  Valuations are a bit cheaper outside the U.S. and this too is increasing the attractiveness of some of these international stocks.

Emerging markets had a strong year last year, finishing 2016 up 11.19%.  The MSCI Emerging markets index is already up 11.45% in the first quarter.  Like developed international countries, emerging countries have shown strong earnings growth, coming off a multi-year decline.  With low valuations, improving fundamentals, and a positive appetite for risk from investors, it is a welcome change to see these markets outpace domestic markets after lagging since 2012.       

Bonds

We are truly in a new era for bonds.  Last year, the Federal Reserve started its move towards normalizing interest rates, away from its policy of near zero rates that had been held since the financial crisis of 2008-09.  In the first quarter, we saw another 0.25% rate hike (the Fed previously raised 0.25% in December), and many anticipate another two to three modest hikes throughout the rest of the year.  Since the U.S. economy has hit the Fed’s targets of 2% inflation and 4.5% unemployment, barring slippage in these numbers or significant volatility in the markets, they have telegraphed moving closer and closer to a “normal” interest rate environment in the next several years, with small rate hikes happening in regular succession.  The Fed has also announced that it will allow bonds that have been held on its balance sheet to mature and “roll off”, which will have a slight tightening effect on the money supply as well.  While the bond market saw a big shift last year right after the election, things have remained fairly calm this year with no new surprises and only short-term rates have seen much movement.  The 10-year Treasury bond yielded 2.4% at the end of the quarter, while the Fed Funds rate stands at 1.0%.  

Looking Forward

We believe the investment markets are a place where rhetoric and politics only matter in the long-run to the degree that they create a real-world impact on the economy and businesses. It might be easier to think of this like the sport of soccer, which my son plays.  In some games, it doesn’t take long to realize that you are dealing with a bad referee or perhaps poor playing conditions, such as freezing cold rain on a muddy field.  These are all relevant factors that do influence the game, but ultimately the game has to be played and good teams will generally beat bad teams regardless of whether these conditions are favorable or not over the course of a season.  Investing is similar in that the environment can be more or less favorable depending on numerous factors, but returns are still needed by investors and “the game must go on”. We use fundamental analysis and a diligent process, backed by a strong understanding of history, to help guide our decisions and to minimize the emotions that so often accompany investing.  We are happy when the sun shines on the markets and the environment looks bright as it has over the last twelve months, but we also understand that things are constantly changing and we must be positioned for whatever market conditions might arise.  We thank you for your trust and will continue to take our responsibility as stewards of your capital with the highest regard.

Sincerely,

Zach Ivey, CFA, CFP®

Chief Investment Strategist

 

The material provided is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.  The opinions expresses are as of April 17, 2017, and may change as subsequent conditions vary.  The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Bridgeworth, LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.  Past performance is not guarantee of future results.  There is no guarantee that any forecasts made will come to pass.  Reliance upon information in this material is at the sole discretion of the reader.  Investment involves risks.

International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulations and the possibility of substantial volatility due to adverse political, economic or other developments.

The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments.

Index returns are for illustrative purposes only and do not represent actual performance of any investment.  Index performance returns do not reflect any management fees, transaction costs or expenses.  Indexes are unmanaged and once cannot invest directly in an index.  Past performance does not guarantee future results.

Neither Bridgeworth nor its content providers are responsible for any damages or losses arising from any use of this information.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing.

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