Inauguration of Uncertainty
Doug Walters
The peaceful transfer of power is now complete and investors hope this will bring clarity on the direction of the new administration. However, given the relative unpredictability of the President, we expect uncertainty to remain a theme throughout the year.
Market Review
Contributed by Doug Walters
U.S. equity markets were down slightly this week as the market struggled to hang on to early gains Friday. With the presidential inauguration dominating the airwaves, it would be easy to forget that the corporate earnings season has begun.
Peaceful transfer
The inauguration of our 45th president is now in the books and the stock market continues to take a relaxed attitude toward the transfer. This is somewhat surprising.
- The stock market dislikes risk and uncertainty. With big changes expected from the new administration, but little known about specifics, one would expect investors to proceed with caution.
- High expectations are built into valuations, but we believe our focus on quality and value, combined with diversification, is positioned well to take advantage of any short-term pull-backs if investors lose their nerve.
Corporate earnings season kicked off in earnest. Traditionally, Financials are the first to report, and about a third of them have done so thus far. What is most notable is the lack of conviction in guidance, with management forced to wait and see what the new administration has in store for their sector.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | -0.1 | 1.5 |
| S&P 400 (Mid Cap) | -0.8 | 0.8 |
| Russell 2000 (Small Cap) | -1.6 | -0.5 |
| MSCI EAFE (Developed International) | -0.9 | 1.7 |
| MSCI Emerging Markets | -0.2 | 3.7 |
| S&P GSCI (Commodities) | -1.2 | -0.8 |
| Gold | 0.8 | 5.0 |
| MSCI U.S. REIT Index | 0.6 | 0.7 |
| Barclays Int Govt Credit | -0.2 | 0.0 |
| Barclays US TIPS | -0.2 | 0.5 |
Economic Commentary
Inflation passes an inflection point
President Donald Trump is inheriting a recovering economy that is now showing signs of rising inflation. The consumer price index (CPI) showed overall prices rose by 2.1% in December from the year before, the most since June of 2014. Gasoline prices rose by 9.1%, medical care supplies by 4.7% and educational books by 5.5%, while used car prices dropped by 3.5% and public transportation by 2.3%.
Rising prices could increase the likelihood of the Federal Reserve raising rates multiple times this year, as evidenced by the 10-year Treasury yield rising. Chairwoman Janet Yellen said in a speech this Wednesday, “It’s fair to say the economy is near maximum employment and inflation is moving toward our goal.”
A strengthening dollar is one factor keeping prices in check. As the value of the dollar increases, goods priced in dollars tend to decrease. The incoming President said last week that he would like to see a weaker dollar but the value of the USD increases when interest rates rise as foreign money is redeposited in dollars. A stronger dollar makes U.S. exports more expensive which could hurt the US manufacturing sector that is operating only at 74.8% of capacity.
Week Ahead
50-50
The UK Supreme Court will decide if the government can submit Article 50 without Parliament’s approval. If the Supreme Court rules against Prime Minister May, this will give Parliament a chance to block Brexit.
- Many members of Parliament have hinted they may vote against Brexit, which may considerably delay the UK’s departure from the European Union.
Tech attack
The Technology sector will headline 4th quarter earnings, with Industrial and Consumer Staples companies adding to the mix.
- Notable Tech companies from our strategies to report are Microsoft Corp. (MSFT), Intel Corp. (INTC), Qualcomm Inc. (QCOM) and Alphabet Inc. (parent of Google) (GOOG).
First look
Preliminary Gross Domestic Product (GDP) results for the 4th quarter will wrap up the week. Economists are expecting 2.2% growth vs. 3rd quarter GDP of 3.5%.
- The expectation is well up on 4th quarter 2015 GDP growth, which was 0.87%.
Strategy Updates
Contributed by , Max Berkovich
STRATEGIC ASSET ALLOCATION
Small caps, big moves
Small caps gave up a little ground this week after rising nearly 20% since November. Last year, investors rushed to buy any stock that might benefit from the new administration’s policies such as corporate tax cuts, reduced regulation, foreign profit repatriation and higher taxes on imports.
- Domestic small caps do not have significant international exposure and thus may perform best during protectionist economic policies as prices for domestic goods become more competitive against imports.
Resume takeoff
As we discussed in the Economics section, interest rates have resumed their ascent this week after the Federal Reserve signaled a stronger case for rate hikes this year.
- The 10-year yield has jumped from 1.87% to near 2.5% since election day as investors are expecting stronger growth and higher inflation, on the back of increased fiscal stimulus.
STRATEGIC GROWTH
Ubiquitous connectivity
Consumer Staples finished as the top sector this week, but Technology made a strong push on Friday. Speaking of Technology…
- Skyworks Solutions Inc. (SWKS), a computer chip maker, reported slight beats on both top and bottom line. Most importantly growth returned to the company before release of the next version of an iPhone. The CEO attributed the success to continued demand for internet of things (IoT) and ubiquitous mobile connectivity.
- We exited a position in an asset manager this past week. The company was a core holding for over a decade for us, but we think growth for the company is in the rear-view mirror now.
STRATEGIC EQUITY INCOME
Mellon-choly
The Industrial sector rose to the top this week, just inching out Consumer Discretionary. Financials lagged this week as earnings reports failed to flame a further rally for the banks. Speaking of earnings and banks…
- The Bank of New York Mellon Corp.’s (BK) 4th quarter earnings were in-line with expectations. The custody bank reported that assets under management declined by 3.9% and assets under custody declined by 2% for the quarter. Cost reductions and interest income gains were offset by a strong dollar.
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