Investment Insights: The muddy waters blues

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team. 

A container ship in the harbor in Asia

U.S. stocks are stuck in the mud; the wheels are spinning, but we don’t seem to be going anywhere. The S&P 500 Index has lost 71 basis points since last week, lagging behind international markets. So far this year, the S&P is up barely over 9% compared to the almost 15% gain for the rest of the world, based on MSCI data. While these returns are certainly not considered flat, it has felt that way over the past month. Low volatility has been the name of the game as stocks gradually, but resiliently, push higher. In fact, the S&P has seen only four trading sessions this year which exceeded one percent – up or down. There doesn’t seem to be enough support in the data for a further extension in the stock markets. The reality is that U.S. investors are in “wait and see” mode amid mixed signals from economic data and political upheaval.

 
U.S. politics remains exceedingly uncertain as turmoil grips the White House and Congress struggles to pass practical legislation affecting healthcare replacement, tax reform, and spending. Although the markets are keeping a close eye on political developments, economic data has also been a topic of concern. Recent data from the U.S. Commerce Department showed a notable decline in durable goods orders and business equipment purchases, which may push the burden of growth from corporate expenditures to U.S. households. The International Monetary Fund recently cut its forecast for U.S. growth from 2.3% this year to 2.1% after removing its assumptions of Trump’s plans to cut taxes and boost infrastructure spending. That number is far below Trump’s prediction of 3% growth – a target that’s been historically rare. According to Bloomberg News, which referenced IMF data, “The only time the U.S. economy accelerated at such a pace came in the early 1980s, when it was recovering from a deep recession.” However, the IMF also noted the U.S. is in its third-longest expansion since 1850. The agency added that the Fed may want to let inflation rise above its target to reduce the risk of disinflation and having to reinitiate a zero interest rate policy.

 
The Fed’s counterpart in Europe, the ECB, has begun to broach the subject of reducing its asset purchase program for the first time since initiating QE in 2009. ECB President Mario Draghi said yesterday that the central bank may adjust down its stimulus as early as September, according to Reuters, as a “strengthening and broadening recovery” sweeps the Eurozone. The ECB’s stimulus had been expanded multiple times over the past few years in contrast to other central banks, which had eyed cutting stimulus and tightening policy. Venezuela and Brazil remain in unrest as corruption and scandal pushed citizens to the streets in protest. Brazilian President Michel Temer has now been formally charged with corruption, which could lead to impeachment; this would likely put a damper on reforms needed to pull the country out of its worst recession ever. Brazil’s IBOV Index, which is comprised of stocks on the Sao Paulo Stock Exchange, has declined about 10% since the corruption stories surfaced in mid-May.

 

Investors may be on relatively calm seas for now, but the water is definitely not clear. These muddy waters have made it more difficult to navigate the current investment environment. Our strategies remain slightly overweight equities and underweight bonds and alternatives. Despite the overweight, our allocations within each asset class have become more defensive as we weigh the risks of different regions across the globe. The center stage risk for domestic markets continues to be a lack of execution on tax reform and fiscal spending, but mixed U.S. economic data and altered policy from the Federal Reserve are pushing their way to the forefront.

 

Chart showing market returns as of June 27, 2017

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Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

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