Happy New Year! What holds 2017?
What a year 2016 was – starting off the year with an immediate 14% plummet in the stock market, for no real reason other than to keep us all guessing. Afterwards, the market recovered quickly only to settle into those ever-maddening “doldrums” that we had been stuck in for 2 years… basically going nowhere. Finally, going into the end of the year, the market took off – emboldened by the possibility that a change in economic policy from a “tax and shift” strategy to a policy designed to enhance the economy’s top line revenue would bring the changes necessary to get the economy firing on all cylinders again.
In general, the economic data has not been bad of late – but nothing to get particularly excited about, either. Much of the growth in bottom-line corporate earnings that we have seen lately has resulted more from cost-cutting than from developing new markets. Signs that the economy has transitioned from the middle stage of the economic cycle (the “prosperity” or “sustained growth” phase) into the “Late Stage” of the economic cycle are becoming more and more apparent.
The fact is that this particular expansion, beginning after the Great Recession ended in early 2009 – has been one of the most anemic expansion since the National Bureau of Economic Research (NBER) started tracking expansions economic cycles. However, a close look at the economic indicators leaves considerable room for optimism. The yield curve (a line that shows the difference in short-term and long-term interest rates) remains steep – meaning that consumers and businesses are still hungry for capital and are willing to pay more for it. Housing starts and permits issued for new homes are continuing to trend higher, as well as are orders for durable goods, both signs of increasing future economic activity.
Donald Trump’s election has stimulated tons of speculation concerning a notably different economic policy than the previous one. While there has been much hand-wringing amongst his detractors and up-whooping amongst his supporters – the fact remains that he has everyone’s attention and there is a different “feel” in the investment community now than was present a few months ago. Most (but certainly not all) economists believe that Trump’s proposals will actually grow the economy and create jobs. However, the fact that it represents a sharp break from the “globalization” policy that has generally been in place for the last 24 years will no doubt create some uncertainty – which will translate to volatility. Additionally, it has been several decades since similar policies were tried, and the effects may be different from what economists expect – both good and bad – and we will discover them together.
At 89 months, our current expansion is the 3d longest on record, with the expansion from 1961 – 1969 being the second longest at 106 months. While it is certainly possible that this expansion can grow to become the longest one on record, it is also likely that eventually we will again go through a recession. Most recessions are nowhere as painful as the last two have been, and it is entirely possible that the next recession will be a merely a short slowdown versus a long and drawn-out period of pain. Either way, we continue to monitor all of the economic data and recession probability models in order to be ready to transition to our Recession Protocols. However – at present – the economic data looks strong and our recommendation is to remain invested at the maximum risk tolerance that is appropriate for each person.
Going forward, it is important to realize that gains from here until the end of the economic cycle are likely to be sporadic – with only several months’ performance driving the entire year’s gains. It is also very likely that bonds and bond funds will struggle to generate meaningful returns as the Fed finally embarks on a series of interest rate increases in order to be in a position to make a “soft landing” possible when the next recession emerges. As such, it is likely that a risk level that constitutes at least 40% equities (stocks) will be necessary to generate any return that can beat inflation.