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Byron, Lisa, Jerry, Tony, Darin and Ian
Volatility returned to the capital markets. After a relatively calm 2017 and a euphoric surge in January, stock prices hit an air pocket in February that set in motion a series of notably up and down trading days for the rest of the quarter. We believe the primary cause was an increase in interest rates, as the yield on the 10-year Treasury elevated toward three percent. Increasing confidence in the upswing of economic activity has motivated the surge in rates. That view was confirmed at the March meeting of the Federal Reserve, which followed through with previously announced plans to bump short-term rates by another quarter-percent. In addition to rising rates, the prospect of new trade tariffs and government intervention in the technology sector seemed to rattle the markets. Volatility is likely to be more pronounced in the markets this year, although we believe the strong forecast for corporate profits and employment will ultimately generate progress for stock prices.
So far, the transition from “monetary stimulus” to “fiscal stimulus” has gone well.
The Fed is gradually reversing the low interest rate policies of recent years, while the federal government is introducing lower corporate tax rates and increased spending on infrastructure projects. Profit gains and rising payrolls should be more than sufficient to overcome the economic drag posed by modestly higher rates. We expect good news to arrive with the corporate earnings announcements that are reported in the first few weeks of each new calendar quarter. Rising profits and the ability to repatriate funds from overseas will help projects to get funded, which will boost wages and jobs. Rising payrolls generate consumer spending that drives the economy, as well as income tax dollars that pay for important government programs.
Interest rates are a potential risk during this period of monetary tightening. In addition to the March bump in rates, the Fed is planning two more rate increases this year and three more in 2019. That suggests short-term rates are headed to around three percent by the end of next year. If economic growth remains on track, the 10-year Treasury yield could easily be over four percent by that time. However, there is room for the Fed to maneuver if conditions were to change. The March meeting was Jerome Powell’s first presentation as incoming Chair of the Fed, and it was a reassuring continuation of the cautious approach pursued by his predecessor, Janet Yellen. The Fed’s primary focus is inflation. So long as inflation remains around two percent, they believe the economy can withstand gradual increases in rates. If a dramatic surge in wages were to spark higher inflation, the Fed could move more quickly. If rising rates stall the economy, the Fed can back off. The Fed’s current outlook is for inflation to remain around two percent, with economic growth in the
2½ to 3 percent range. That scenario is a productive one for investors.
The potential for misuse of data collected by social media companies has raised the risk of government intervention in that industry. A handful of companies dominate social media, and they collect an astounding amount of detailed information about their users. That allows them to tailor the articles, advertisements and opinion pieces that flow to each user’s site. As a result, these companies have become a powerful conduit that controls what we see of the world and what the world sees of us. This is a big issue as younger people rise to positions of influence, since their views are more likely to be affected by social media. In the U.S. alone, roughly 88 percent of people 18 to 29 years of age are using social media, and many of them rely on those sites as their primary source for news and information. Facebook appears to be a natural target for investigations of data abuse, since they are the largest social media provider. More than two-thirds of the U.S. adult population (of all ages) uses Facebook, and most of the users visit the site at least once each day.
On an administrative note, clients will be seeing some changes to the management of uninvested cash within their accounts. The use of money market sweep funds is going away, replaced by a bank sweep feature that includes traditional FDIC insurance. This change, the result of regulations pertinent to money market funds, is becoming commonplace in the industry. There is nothing required on your part, as the change will happen automatically. While the Fed has been raising short-term interest rates, cash continues to earn an extremely low rate of return, so we generally do not recommend holding large cash balances. Also, for cash that may be held for longer periods of time, we can use position-traded money market funds or other short-term fixed income assets to earn a better rate of income than what is offered by the bank sweep feature.
Earnings, interest rates and employment continue to give us the most relevant view into how well our economy is working. Stock prices react to forecasts for these variables. Earnings and employment are very strong right now, while expectations for rising interest rates pose a modest headwind. Volatility in the capital markets reflects this dynamic, although we believe the net effect of these forces will prove beneficial to investors.
Welcome to Spring, and please give us a call if you have any questions or thoughts you would like to discuss.
Past performance is not indicative of future results. The information contained in this report is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the items mentioned. The information, while not guaranteed as accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.
West Oak Capital, LLC
2801 Townsgate Road, Suite 112
Westlake Village, California 91361
Ph. 805.230.8282, Fax 805.230.8283