Leigh Lowman, Investment Manager
Risk assets continued with their upward momentum, generally finishing positive for the month. Politics dominated headlines with the spotlight on the Trump administration. Speculation on whether the president interfered with a FBI investigation caused equities to drop mid-month only to quickly rebound based on the strength of positive fundamentals. Overseas, international markets reacted positively to the French election win of Macron, known for his moderate political stance. Expectations have strengthened for an additional Fed rate hike in June as domestic data leans positive with inflation remaining under control and the economy close to full employment.
The S&P 500 Index was up 1.4%. Sector performance was mixed with technology (+4.4%) and utilities (+4.2%) posting the largest gains for the month. On the negative side, energy (-3.4%), financials (-1.2%) and telecom (-1.0%) continued to lag and are all negative year to date. Small caps, which have shown to be more dependent on the “Trump Trade”, finished the month negative and significantly lag large and mid cap stocks year to date. Growth outperformed value and leads year to date.
Developed international equity was up 3.8%, outperforming domestic equities for the third month in a row. The positive outcome of French election boosted markets but much uncertainty currently surrounds the Italian general election with the populist and mainstream parties currently neck-and-neck in the polls. Consumer confidence in the UK also rose but still remains in negative territory as Brexit proceedings continue to move forward. Data from Japan came in positive with a rebound in industrial production and uptrend in housing starts. Emerging markets remained resilient, posting a 3% return, despite the political chaos erupting out of Brazil during the month.
The Bloomberg Barclays US Aggregate Index was up 0.8%, with all sectors posting positive returns. Despite rising 15 basis points mid-month, the 10 Year Treasury yield ended the month slightly below where it began, at 2.2%. High yield spreads remained relatively unchanged, contracting 8 basis points. TIPS were flat due in part to inflation data coming in below expectations. Municipals were up 1.6%.
We remain positive on risk assets over the intermediate-term, although we acknowledge we are in the later innings of the bull market and the second half of the business cycle. While our macro outlook is biased in favor of the positives and recession is not our base case, especially considering the potential of reflationary policies from the new administration, the risks must not be ignored.
We find a number of factors supportive of the economy and markets over the near term.
- Reflationary fiscal policies: Despite a rocky start, we still expect fiscal policy expansion out of the Trump Administration, potentially including some combination of tax cuts, repatriation of foreign sourced profits, increased infrastructure and defense spending, and a more benign regulatory environment.
- Global growth improving: U.S. economic growth remains moderate and there are signs growth outside of the U.S., in both developed and emerging markets, is improving.
- Business confidence has increased: Measures like CEO Confidence and NFIB Small Business Optimism have spiked since the election. This typically leads to additional project spending and hiring, which should boost growth.
- Global monetary policy remains accommodative: The Federal Reserve is taking a careful approach to monetary policy normalization. ECB and Bank of Japan balance sheets expanded in 2016 and central banks remain supportive of growth.
However, risks facing the economy and markets remain, including:
- Administration unknowns: While the upcoming administration’s policies are currently being viewed favorably, uncertainties remain. The market may be too optimistic that all of the pro-growth policies anticipated will come to fruition. The Administration has quickly shifted from healthcare to tax reform legislation. We are unsure how Trump’s trade policies will develop, and there is the possibility for geopolitical missteps.
- Risk of policy mistake: The Federal Reserve has begun to slowly normalize monetary policy, but the future path of rates is still unclear. Should inflation move significantly higher, there is also the risk that the Fed falls behind the curve. The ECB and the Bank of Japan could also disappoint market participants by tapering policy accommodation too early.
The technical backdrop of the market is favorable, credit conditions are supportive, and we have seen some acceleration in global economic growth. So far Trump’s policies are being seen as pro-growth, and investor and business confidence has improved. We expect higher volatility as we digest the onset of new policies under the Trump administration and the actions of central banks, but our view on risk assets remains positive over the intermediate term. Higher volatility can lead to attractive pockets of opportunity we can take advantage of as active managers.