February 2017 Monthly Outlook
Thus far in 2017, there seem to be more tailwinds than in recent years with the absence of weather-related issues and the falling commodity prices seen in 2016—most notably oil. Capital investments in the energy sector are rebounding following sizable reversals a year ago, and the rig count is climbing again. Moreover, building permits and housing starts are holding up; non-defense capital spending is rising; and consumers, buoyed by gains in disposable income and household wealth, remain supportive.
The Conference Board Leading Economic Index® (LEI) for the U.S. was increased 0.6 in January to 125.5. “The U.S. Leading Economic Index increased sharply again in January, pointing to a positive economic outlook in the first half of this year,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “The January gain was broad based among the leading indicators. If this trend continues, the U.S. economy may even accelerate in the near term.”
The continued strength in the economy has caused inflation to reach a multi-year high of 2.3%, meeting the Federal Reserve’s inflation targets. This has caused the Federal Reserve to indicate they expect to raise short term interest rates three times in 2017. Indicators point to the US economy accelerating in the short term and in the long term continuing a slow but steady growth rate of ~2% annually. We remain in the late stages of a long business up-cycle without major excesses that brought down some prior economic upturns.
Stock and Bond Market Commentary:
U.S. stocks had another strong month with the S&P500 Large Cap index increasing 3.93% in February, bringing the 2017 year to date return to 5.79%. Interest rates decreased slightly in February, causing bonds and real estate to increase 0.65% and 4.37% respectively.
Stocks increased due to an optimistic outlook that earnings growth may accelerate. The recent fourth quarter was strong for corporate earnings, with the majority of companies beating expectations on the bottom line, and with just over half of all companies beating on the revenue line. That performance was solid enough to push markets to new highs and caused valuations to continue their increase. As I have noted in past monthly newsletters, current stock valuations are concerning, especially if earnings growth does not accelerate. The two biggest factors with stock investment performance over a long term are valuations and earnings, but there is little connection between these factors and stock performance over the short term. There are no credible methods to predict stock performance in the short term (within the next 12-24 months). Therefore it’s best to make investment decisions based on a methodical process that is highly dependent on your time horizon. Over the longer term, investment in businesses (i.e. stocks) should provide superior returns to all other classes (such as bonds and real estate).