2017 Mid-Year Update
I trust this letter finds you enjoying the beautiful summer! It is also a wonderful time to provide some economic context as we complete the first half of 2017 and look ahead to the rest of the year and beyond.
The U.S. experienced stock market gains during the first half of 2017 with the technology heavy NASDAQ Composite up 14%, the small stock barometer Russell 2000 index up 4%[i], the Dow Jones Industrial Average and the S&P500 both up 8% in the last six months[ii]. Globally, twenty-six of the top thirty foreign stock markets by market cap have had positive gains during the first half of 2017[iii]. In European countries, such as France and Germany which account for half of the Euro GDP, earnings surprises have been the trend the past tweleve months and valuations are attractive compared to historical price to earnings multiples[iv]. Emerging market stocks, the darling of the early 2000s then trailed developed countries after the financial crisis of 2009 with slower growth prospects, heightened currency volatility and declining commodity prices, have begun to show life in 2017 outpacing developed counties the past 18 months[v].
Meanwhile the VIX Index is at its lowest level in 20 years and on pace to set its lowest annual average on record[vi]. Sometimes refered to as the “fear guage,” the VIX measures the implied volatility of at-the -money, 30-day options on the S&P500 Index; the higher the number, the higher the implied risk of imminant stock market decline. Keep in mind, this is what investors think might happen based on their buying of options to protect gains or take advantage of declines. Keep in mind, implied volitility as measured by the VIX is not the same as actual volitility, or standard deviation, which is measured by the market’s daily movement. Although implied volitility is usually a little higher than actual volitiility, the two are closely correlated over time[vii].
The U.S. dollar has declined 5.6% in 2017 as economies around the world begin to accelerate; however, the U.S. dollar reached a 14 year high in late 2016 as investors anticipated tax cuts and infrastructure spending that may accelerate U.S. GDP growth[viii]. A pullback from the recent six year bull market in the U.S. dollar generally helps U.S. multinationals and exporters to be more competitive overseas[ix].
The Wall Street Journal reports “In the past 20 years, only four first-half ralies have been as widespread or better than the current global surge. Two of them preceeded sharp stock market crashes and two others came at the start of long bull markets”[x]. This fact? prompts the real question we all want to know—will this be the beginning of another leg of the current bull market[xi], or will we see stocks and subsequently the economy begin to recede? The current bull market in U.S. stocks began in March 2009 right after the panic lows of the 2008 housing crisis. Corrections in the market can occur at any time, but corrections are natural and they will come and go. Fundamentally, what drives stocks and markets are earnings and the expectations for continued growth[xii].
The Federal Reserve raised interest rates by another ¼ point in June as part of the Fed’s statement to remove excess reserves and begin reducing its balance sheet as the economy begins to gain traction[xiii]. This is the fourth rate hike of ¼ point since December 2015 in a process that may take a few years to complete[xiv]. Compared to last quarter’s projections, the Fed now is expecting slightly more growth, less unemployment and less inflation[xv]. Personal income and spending moved higher in May; income has increased 3.5% during the past year with consumer spending slightly higher[xvi]. Consumer debts are at a record high in dollar terms, but so are assets, and if we look at the two on a personal balance sheet, debts to assets are the lowest since 2000. Furthermore, the financial obligations ratio, comparing debt and other recurring payments to income, is close to the lowest level in 30 years[xvii]. Consumer prices fell slightly in May, but are up 1.9% over the prior year, verses 1% the prior year ending in May 2016 and remain in a rising trend[xviii]. Retail sales declined in May by 0.3% mainly due to the drop in gasoline prices and are up 3.8% from a year ago. Usual drivers of increased consumer spending are job and wage growth as well as low levels of debt[xix].
Real Gross Domestic Product (GDP) growth was revised up on the final revision to 1.4% for the first quarter with the largest contributors coming from consumer spending, business investment and home building[xx]. Manufacturing as measured by the ISM Manufacturing Index rose in June to the fastest pace in three years and highest level since 2011. Manufacturing growth continues to remain broad based across the most sectors and continues the trend higher since November 2016[xxi]. Although the Producer Price Index (PPI) was unchanged in May due mainly to the drop in oil and gas, the core PPI, excluding food and energy increased and is up more than 2.1% in the last tweleve months, the first move above 2% since 2014[xxii].
Existing home sales increased in May and are up 2.7% over the past year; supplies are tight and the median price has been rising for 63 consecutive months reaching a new high in May[xxiii]. New home sales moved up in May by just under 3% and are up almost 9% in a year[xxiv]. The national Case-Shiller home price index is up 5.5% in the past year ending April 30, 2017; home prices increased 5.1% the prior year ending April 30, 2016[xxv]. New home sales may fare better as mortgage credit standards are relaxed and current renters begin to chip away at our historically low homeownership rate[xxvi]. Housing starts declined 5.5% in May which was lower than expected, but digging into the numbers may provide context. Both single-family and multi-family units are responsible for the drop in May’s number, however single-family home starts are up 8.5% in the last year while multi-family units are down 23% which is generally a good sign for the economy. Single-family homes contribute approximately twice as much to our gross national product as multi-family units[xxvii].
I read an interesting article positing the thesis that the Fed’s Quanitative Easing (QE) didn’t work as some economists have proclaimed. Economists had asserted that QE boosted money supply and boosted stock and bond prices thus lifting an ailing economy after the financial crisis of 2008. As a quick primer, with QE, the Fed created 3.5 trillion in new money and bought U.S. Bonds with that newly printed currency; however in hindsight, we now know most of it remained as excess reserves in the banks they bought them from and did not circulate[xxviii]. The U.S. M2 money supply, the short-term deposits and money in circulation, never accelerated as the Fed continued to buy bonds, and GDP growth, although stabilized, remained below historical averages. After the Fed stopped QE the stock market continued higher and interest rates have remained stable[xxix]. This could also be why we did not see inflation rear its head in the face of the amount of new money printed—most of it never got into circulation.
Will Congress repeal, repeal & replace, keep or just modify the current Affordable Health Care Act (AHA), and will it ultimately be good policy for Americans and our national fiscal house? I believe it all boils down to Medicaid spending. Medicaid is a jointly funded federal and state health insurance program for the poor, elderly and disabled, providing coverage for nursing homes for the elderly and long-term care for the disabled once poverty-stricken. Medicaid currently covers 20% of Americans, or roughly 70 million people, provides the payment for half of all babies born and is the largest payer for substance abuse treatment in the United States[xxx]. In Ohio, the largest state expenditure is on Medicaid at more than 37% of the state’s budget and that does not count the Children’s Health Insurance Program (CHIP), institutional and community care for the mentally ill and developmentally disabled, or public health programs. By contrast, the state spends 20% on K-12 and higher education[xxxi].
In 1987, federal Medicaid spending was 3% of all federal expenditures, today it stands at 10% due in part to our rising health care costs, but due in larger part to the raised income eligibility under the expansion provision of the AHA which allowed more than 11 million more Americans to have health insurance through Medicaid[xxxii]. The debate in Congress and among Americans goes something like this: pro-Medicaid expansionists believe Medicaid is less expensive per person than Medicare or private insurance and provides a cost effective solution for our less fortunate populations, the elderly and the disabled[xxxiii]. Anti-Medicaid expansionists believe federal spending is unsustainable and since Medicaid is one of the fasterst growing programs within the federal budget, its growth needs to be controlled[xxxiv]. Current Republican Proposals on Medicaid funding involve capping the amount each state receives per year as a block grant and allowing each state more flexibility with their Medicaid program, as opposed to the open-checkbook method now employed. Although proposed funding amounts would be at or near the current levels, pro-Medicaid expansionists argue that this may put added pressure on states in the future to pick-up any shortfall when federal payments may not adequately reflect the actual growth of the program and actual costs in each state. Anti-Medicaid expansionist believe the capping of benefits in the form of a block grant and providing more flexibility for each state would enable individual states to create programs that are more cost effective and work more efficiently for their citizens within their states[xxxv]. The debate goes on…
Health Care Reform is important to complete so that Americans can afford and have access to quality healthcare. It is also vital so that a realistic budget can be formulated based on that legislation. A good fiscal house is vital to every American. No matter what path Congress takes with healthcare or any other legislation, we must be able to pay for the changes so we don’t kick the can down the road for the next generation. A great midwestern state, Illinois, has not had a budget in more than two years, has not had a balanced budget in 15 years and is now $15 billion in debt[xxxvi]. Illinois is now confronted with raising taxes and reducing state expenditures for it’s current citizens based on past political decisions that were kicked down the road. Congress also has other policy proposals from the Trump Administration—deregulation, reduced individual and corporate tax rates, infrastructure spending, Dodd-Frank financial improvement and immigration reform—that need to be debated, and if appropriate, enacted for the American people.
You just used your Uber app for a ride—and a driverless car shows up. The age of artificial intelligence (AI) is upon us ushering in the sixth technological revolution since the 1700s—following the industrial revolution, the age of steam & railways, the age of steel, electricity & heavy engineering, the age of oil, the automaobile and mass production, the age of information and telecommunications[xxxvii]. AI refers to technology that enables computers to simulate portions of human thinking without being programmed with every detail of contingency. Machines can teach themselves by analyzing data from the web and internet connected devices, including your smartphone. The explosion of AI has been linked to increased processing power, the smartphone and advent of cloud computing[xxxviii].
Machines thinking for themselves and conversing with humans is the stuff right out of the Terminator Movies, using reason, logic, experience and massive amounts of data to figure things out on their own. AI is already transformative for many industries such as healthcare, transportation, and manufacturing, providing potential efficiency, productivity and profit potential. AI has the potential to improve the standard of living of people while offering investors opportunities to review[xxxix]. AI is also a threat to jobs as robots and computers displace workers and impact income in industries that utilize (or will utilize) IA. Facebook’s news feed uses machine learning to provide feed to each member. Machine learning provides for Amazon’s recommendation algorithm. Google and Apple are two companies that are advancing the
landscape with this technology. Companies from many industries are exploring the possible applications for AI. Automation with robots is not a new phenomenon, but between 2010 and 2015 sales of robots increased 16% per year with 254,000 industrial robots sold in 2015 worldwide as AI evolved[xl].
Our LW Gameplan
Our Leshnak Wealth Portfolio Models are globally diversified and strategically constructed, with a tactical component. We have a bias toward value which prescribes a requirement for dividend yield from our investment positions. In simple terms, we have investment positions in eight asset classes: domestic equities, foreign developed stocks, foreign emerging market equities, domestic bonds, foreign bonds, cash equivalents, commodities, infrastructure, natural resources and real estate.
How much of each asset class (if any) we hold in the aforementioned asset classes is based on your unique risk tolerance, financial resources and personal goals and objectives. Moreover, we have a portion of each portfolio that is tactical and flexible. This allows the manager to move assets into the sectors that best fit current market conditions based on their methodology. Our portfolio construction has two other vital components—we require dividends from each position so no matter what the market is doing day to day, we still have a dividend coming into the portfolio for income or to reinvest. Lastly, we overweight value versus growth in our allocation models which we believe puts us in the position of the “turtle”, in the proverbial tortoise verses the hare scenario, over the long-term with equities.
As your financial fiduciary, the Leshnak Wealth Team cares deeply about your financial well-being, and will monitor for rebalancing opportunities that may add value to your portfolio, or to be defensive as conditions might warrant. As always, please call with questions or if you wish to discuss your specific portfolio in greater detail.
–Bob Leshnak, July 4, 2017
The investment decisions are those of Robert M. Leshnak, Jr., CLU, ChFC, CFP®, MS, EA as of 7/4/2017 and are subject to change. The information contained herein is only intended for Leshnak Wealth clients invested in the Leshnak Wealth Portfolio Models. No forecasts or recommendations are guaranteed. The technical data utilized as part of the investment decisions does not guarantee future positive results. Performance, especially for short periods of time, should not be the sole factor in making investment decisions. The information contained herein does not constitute client specific investment advice or take into account a specific client’s particular investment objectives, strategies, tax status, resources, or investment time horizon. No investment strategy such as asset allocation, diversification, tactically overweighting sectors, or utilizing fundamental and technical analysis can always assure a profit, nor always protect against a loss. The information presented is not intended to be a substitute for specific individualized tax, legal, or financial planning advice. The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time. Investing involves risks in regards to all of the investment products mentioned in this commentary, including the potential loss of principal. International investing involves additional risks including risks associated to foreign currency, limited liquidity, government regulation, and the possibility of substantial volatility due to adverse political, economic, and other developments. The two main risks associated with fixed income investing are interest rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the insurer of the bond will not be able to make principal and interest payments. Investments in commodities may entail significant risks and can be significantly affected by events such as variations in the commodities markets, weather, disease, embargoes, international, political, and economic developments, the success of exploration projects, tax and other government regulations, as well as other factors. Indexes are unmanaged and investors are not able to invest directly into any index. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.
Leshnak Wealth is a marketing designation. Securities and investment advisory services offered through FSC Securities Corporation, member FINRA/SIPC and a registered investment advisor. Additional investment advisory services offered through Southland Equity Partners, LLC, a Registered Investment Advisor. Insurance services offered through Leshnak Financial Group, LLC. Tax Preparation offered through Leshnak Tax Preparation, LLC. Listed entities are not affiliated with FSC Securities Corporation.
[i] Money.CNN.com 7/1/2017
[ii] Russolillo, Steven. “Global Stocks Cap Strong First Half”; The Wall Street Journal, July 1, 2017.
[iii] Russolillo, Steven. “Global Stocks Cap Strong First Half”; The Wall Street Journal, July 1, 2017.
[iv][iv] “Eurozone: Three Forces Driving the Rally”; iShares by Blackrock, June 2017.
[v] “Emerging Markets: A Tale of Improving Fundaments or Increased Risk”; T. Rowe Price, June 16, 2017.
[vi] Driebush, Corrie and Gold, Riva. “Stocks Ring Up a Robust Start to Year”; The Wall Street Journal, July 1, 2017.
[vii] Hooper, Kristina. “Are investors becoming numb to risk? A low fear guage might not be a bad thing—as long as investors don’t ignor fundamentals”; Invesco Weekly Market Review, 6/29/2017.
[viii] Dulaney, Chelsey. “Dollar is Pressured from All Directions”; The Wall Street Journal, July 3, 2017.
[ix] Dulaney, Chelsey. “Dollar is Pressured from All Directions”; The Wall Street Journal, July 3, 2017.
[x] Russolillo, Steven. “Global Stocks Cap Strong First Half”; The Wall Street Journal, July 1, 2017.
[xi][xi] Wesbury, Brian and Stein, Robert. “The Bulls Keep Running”; First Trust Monday Morning Outlook, July 3, 2017.
[xii] Wesbury, Brian and Stein, Robert. “The Bulls Keep Running”; First Trust Monday Morning Outlook, July 3, 2017.
[xiii] Wesbury, Brian and Stein, Robert. “Less Loose”; First Trust Monday Morning Outlook, June 12, 2017.
[xiv] Wesbury, Brian and Stein, Robert. “QE Didn’t Work”; First Trust Data Watch, June 19, 2017.
[xv] Wesbury, Brian and Stein, Robert. “Fed Hikes Rates Again, Sets Plan to Re-Normalize Balance Sheet”; First Trust Research Reports, June 14, 2017.
[xvi] Wesbury, Brian and Stein, Robert. “Personal Income Increased 0.4% in May”; First Trust Data Watch, June 30, 2017.
[xvii] Wesbury, Brian and Stein, Robert. “Personal Income Increased 0.4% in May”; First Trust Data Watch, June 30, 2017.
[xviii] Wesbury, Brian and Stein, Robert. “The Consumer Price Index Declined 0.1% in May”; First Trust Data Watch, June 14, 2017.
[xix] Wesbury, Brian and Stein, Robert. “Retail Sales Declined 0.3% in May”; First Trust Data Watch, June 14, 2017.
[xx] Wesbury, Brian and Stein, Robert. “Real GDP Growth in Q1 was Revised up to a 1.4% Annual Rate”; First Trust Data Watch, June 29, 2017.
[xxi] Wesbury, Brian and Stein, Robert. “The ISM Manufacturing Index Rose to 57.8 in June”; First Trust Data Watch, July 3, 2017.
[xxii] Wesbury, Brian and Stein, Robert. “The Producer Price Index was Unchanged in May”; First Trust Data Watch, June 13, 2017.
[xxiii] Wesbury, Brian and Stein, Robert. “Existing Home Sales Increased in 1.1% in May”; First Trust Data Watch, June 21, 2017.
[xxiv] Wesbury, Brian and Stein, Robert. “New Single-Family Home Sales Rose 2.9% in May”; First Trust Data Watch, June 23, 2017.
[xxv] Wesbury, Brian and Stein, Robert. “Real GDP Growth in Q1 was Revised Up to a 1.4% Annual Rate”; First Trust Data Watch, June 29, 2017.
[xxvi] FRED Economic Data, Economic Research at the Federal Reserve Bank of St. Louis; 7/1/2017 https://fred.stlouisfed.org/series/RHORUSQ156N
[xxvii] Wesbury, Brian and Stein, Robert. “Housing Starts Declined 5.5% in May”; First Trust Data Watch, June 16, 2017.
[xxviii] Wesbury, Brian and Stein, Robert. “QE Didn’t Work”; First Trust Monday Morning Outlook, June 19, 2017.
[xxix] Wesbury, Brian and Stein, Robert. “QE Didn’t Work”; First Trust Monday Morning Outlook, June 19, 2017.
[xxxi]“Ohio State Budget and Finances”; BallotPedia.org, July 3, 2017.
[xxxii] Kiefer, Francine. “Why Medicaid is central to healthcare debate”; The Christian Science Monitor, 6/22/2017.
[xxxiii] Kiefer, Francine. “Why Medicaid is central to healthcare debate”; The Christian Science Monitor, 6/22/2017.
[xxxiv] Kiefer, Francine. “Why Medicaid is central to healthcare debate”; The Christian Science Monitor, 6/22/2017.
[xxxv] Kiefer, Francine. “Why Medicaid is central to healthcare debate”; The Christian Science Monitor, 6/22/2017.
[xxxvi] Domonoske, Camila. “Illinois Governor Vetoes Budget Deal; Legislators Begin Override”; NRP.org, 7/4/2017.
[xxxvii] American Funds “Artificial Intelligence: It’s Not the Future, It’s Now”; The Long View-Investment Insights, April 2017.
[xxxviii] American Funds “Artificial Intelligence: It’s Not the Future, It’s Now”; The Long View-Investment Insights, April 2017.
[xxxix] American Funds “Artificial Intelligence: It’s Not the Future, It’s Now”; The Long View-Investment Insights, April 2017.
[xl] American Funds “Artificial Intelligence: It’s Not the Future, It’s Now”; The Long View-Investment Insights, April 2017.