Aaron Schaefer

Apr 10 2017

The Economy and Market from Here… at Hills April 2017

The Economy and Market from Here...at Hills.

The stock market continued its march upward in the first quarter. Domestic stocks as measured by the S&P 500 rose 6.07% through March 31st. International markets fared slightly better, as the MSCI EAFE rose 7.39% over the same period. These strong upward market moves were likely the result of anticipated policy actions from the current administration, which are likely to provide fiscal stimulus. These include infrastructure spending, regulation reform, corporate tax reform, and the potential for repatriation of corporate earnings back to the United States. While we do not believe stocks are necessarily overvalued—especially should anticipated policy changes progress swiftly—we have trimmed equities on market strength to keep allocations at levels commensurate to risk levels agreed upon with our customers.

The economy has improved over the last year. Payrolls are increasing and the unemployment rate is at a 16-year low. Inflation has also been increasing–though the recent drop in oil prices may relieve some of the inflationary pressures going forward. The Federal Open Market Committee (The Fed) decided to raise rates at their meeting in March. The Fed has also indicated that two more hikes are likely before the end of the year. As a result, interest rates have been on the rise. The 10-year Treasury recently yielded 2.61%, up from 1.79% at the end of first quarter 2016 before falling back to 2.4% by quarter-end. Short-term rates also increased, leading to lackluster returns for fixed income, which should be expected in a rising rate environment.

Our view is that the strength of the recent rally in stocks was generally unanticipated by the market. As noted above, the rally has so far been grounded on the expectation that initiatives related to tax reform, corporate balance sheet repatriation, rebuilding current healthcare law, and infrastructure spending are all positive actions. However, we think as time passes it may be discovered that achieving these objectives might be more difficult than anticipated. Additionally, other stated priorities such as wall building and border tariffs might prove more disruptive than expected. Budget limitations are also a concern. Unintended consequences may result as there is a critical need for access to certain imports, which could be put at risk by changes in trade policy. These are a few of the potential downside risks to the outlook. We are concerned that the market has priced in a very optimistic outcome and that near-term downside risk is currently a higher probability than near-term upside risk.

Some experts believe that that the Fed’s interest rate hike will accelerate the rally as it could suggest that an increase confirms economic expansion. Maybe; however we are content trimming stocks on strength and maintaining our tactical decision to remain overweight stocks. Our tactical positioning is not grounded on an interpretation of near-term market potential. Instead, it is based on our view that stocks provide a long-term inflation hedge while bonds do not. Conversely, we believe bonds will struggle to add value in a rising rate environment.

Our long-term view that stocks represent the best opportunity to build wealth remains unchanged. Tactically we remain overweight domestic stocks, but underweight international stocks. We have been overweight stocks for several years, and accordingly have enjoyed the luxury of being net sellers of equity on rallies to fund distributions or rebalance portfolio allocations.

As always, if it has been a while since you’ve visited with us about your financial goals, please feel free to contact your account administrator. We will find a mutually convenient time to review your account and determine if the current allocation is still appropriate for your circumstances.

Some trust products and IRA contributions/balances are not a deposit, not FDIC insured by any federal government agency, not guaranteed by the bank and may go down in value.
Aaron Schaefer

About Aaron Schaefer

Aaron Schaefer is Vice President, Trust Investment Officer at Hills Bank’s North Liberty location on Forevergreen Road. He has been at Hills Bank since 2004 and manages the investment area of the Trust and Wealth Management division. Aaron can be reached at aaron_schaefer@hillsbank.com.

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