June 30, 2017

News flow and events during the quarter were anything but quiet.  The French had an important election seen as a potential litmus test for the strength of the European Union.  President Trump fired FBI Director James Comey.  This prompted widespread criticism and the appointment of Bob Mueller as Special Counsel to investigate whether or not the President attempted to influence Director Comey to shut down an investigation into former National Security Director Michael Flynn.  Meanwhile, Congress continued to work on a new healthcare bill following a setback with ‘repeal and replace’ earlier in the year.  The desire to address Obamacare shuffled other legislative priorities to the back of the line.  On the monetary policy front, the Federal Reserve kept its promise to gradually raise interest rates, hiking the Fed Funds rate by a quarter-point in mid-June while also detailing its plans to begin the process of shrinking its massively inflated balance sheet.  Lastly, London had to endure several horrific terrorist attacks while worst case scenarios were averted in purported terrorist attacks in Brussels and Paris.

However, the markets barely shuddered in response, and market volatility as measured by the VIX remained near decades-long lows. Perhaps investors simply shut out the political noise and took their cue from decent economic and earnings fundamentals.  U.S. economic reports, while hardly blistering, did show some improvement from tepid first quarter readings.  Growth in the rest of the world also seemed to pick up a little bit of steam.  Meanwhile, we appear to have emerged from a multi-year earnings slump, with Q1 S&P 500 sales and profits showing year-on-year growth for the first time since late 2014/early 2015.    Some of the improvement was simply optics – since results in the year ago period were particularly weak given significant declines in oil and other commodity prices in 2015/early 2016.  The mere fact that the energy and materials sectors weren’t significant drags on profits this year made improvement highly likely.  Even so, profit growth seemed to have improved more broadly.

 

Source:  Russell.  Returns Rolling 3 Months

Notwithstanding solid share price gains during the quarter, there was a major underlying shift in market leadership with growth style benchmarks accounting for a significant portion of the market’s gains the last few months.  In effect, the market unwound the powerful post election “Trump trade” which was led by mostly cyclical/value areas of the market at the expense of growth stocks.  The post-election rally was underpinned by the belief that Trump’s legislative agenda of tax reform, lighter regulatory burdens and increased infrastructure spending would jolt the U.S. economy from its enduring, yet uninspiring, growth rate of approximately 2% in recent years.  This in turn would benefit economically sensitive sectors like energy, financials and industrials.  Now seven months since the election, the agenda appears stalled.  First half U.S. GDP growth looks to average the same 2% we’ve experienced over the last few years. Inflation remains low and Treasury yields have given back some of their post-election movements. Oil prices, too, are toward the bottom of their year-long range. Lastly, the yield curve has flattened following a swift steepening last December. This all served to put a damper on the enthusiasm for sectors deemed to benefit the most: financials, energy, materials and industrials. Investors rotated back to those sectors perceived least dependent upon a raft of new fiscal stimulus, notably technology.

Our Clients’ holdings are benefiting from improving global economic growth due to their strong brands and entrenched global presence.  In addition, they operate from financial strength and are better able to cope with what is likely to be higher interest expense as the Federal Reserve gradually raises interest rates.