Market Watch – July 2017

We are pleased to provide you with our quarterly newsletter featuring the status of our investment class weightings, our interpretation of recent data and our outlook for the future. If you have any questions about any topic, we hope you will not hesitate to contact us.

Status of our Investment Class Weightings

Changes from our April 2017 Market Watch are noted in italic.

US Large Cap Sectors –

Overweight – Financials and Technology
Neutral – Consumer Discretionary, Consumer Staples, Health Care, Industrial and Materials
Underweight – Energy (↓)
No Weighting - Utilities

US Mid and Small Cap – Decrease exposure to Small Cap (↓).
International Developed Markets – Increase exposure to Europe (↑).
Emerging Markets – Maintain all weightings.
Alternative Strategies – Maintain all weightings.

We will continue to target an average fixed income portfolio duration in the short-to-intermediate term, or about 3 to 7 years.

Multi-sector Bond Funds – Maintain all weightings.
Investment Grade US Corporate Bonds – Maintain all weightings.
High Yield US Corporate Bonds – Maintain all weightings.
Investment Grade Municipal Bonds – Maintain all weightings.

Data – For 2017, we see the following equity benchmark returns: US Large Cap – DJIA (+7.71%) and S&P 500 (+8.07%), US Small Cap - Russell 2000 (+4.47%) and International - ACWX (+13.21%). On the earnings front, for Q2 2017 we see an estimated earnings growth rate of +6.5% for the S&P 500, with the Energy sector projected to report the highest earnings growth of all sectors at +401%. GDP, the broadest measure of economic output, for Q1 showed an annualized growth rate of a seasonally on trend +1.4%. Volatility (as measured by VIX) remained low finishing Q2 at just 11.44, far below the long run average of 20.0. Domestic economic data for Q2 was generally mixed. During the quarter, the yield on the benchmark 10-year US Treasury fell from 2.39% to 2.27%. Thus far in 2017, the Barclays US Aggregate Bond Index has risen +1.34%. Monthly job growth averaged 130,000 in March, April and May (compared to 2016 monthly average of 182,000) as the national unemployment rate fell to 4.3%. New weekly unemployment claims averaged a low 240,800 in Q2 (compared to 242,000 in Q1) providing a positive outlook for the domestic job picture. Job growth and unemployment data suggest that the US economy may very well be at or near a theoretical level of full employment. Consumer confidence, as measured by the Conference Board, declined during Q2 though still remains at an elevated level. Responses to the June Manufacturing Business Outlook Survey “suggest continued growth for the region’s manufacturing sector. All the broad indicators remained at high positive readings, suggesting continued expansion.” Retail sales data was ok in March (+0.1%) and April (+0.4%) before falling in May (-0.3%). The housing sector failed to regain momentum after a difficult winter quarter. Housing starts have now fallen for three consecutive months, while new home sales offered little relief in April (-7.9%) or May (+2.9). CPI fell 0.1% in May and over the last 12 months the all items index increased 1.9%, a level below the Fed target of 2.0%.

Outlook – On June 14th, the Federal Open Market Committee (FOMC) voted, as expected, to raise the targeted federal funds rate 25 bps to a range of 1.0% to 1.25%. While this rate hike was expected, what surprised investors was the way in which the Fed was able to downplay recent softening inflation data which has fallen for four consecutive months. The softening inflation data has raised concerns that the Fed will continue to raise rates just as the ongoing recovery begins to stall. The unease that the Fed will move too quickly suggests weakening optimism in the market just as stock prices have reached historic highs. The worries also mark a shift from earlier in 2017, when economic indicators suggested to some that the Fed was falling behind the curve in tightening policy. On the matter of softening inflation the recent Fed statement offered this: “The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2% in the near term but to stabilize around the Committee’s 2% objective over the medium term.” In the June 14th Fed statement we also learned of the Fed’s stated intention to “begin implementing a balance sheet normalization program this year, which would gradually reduce the Federal Reserve’s securities holdings by decreasing reinvestment of principal payments form those securities.” The Fed’s balance sheet now stands at $4.5 trillion, of which over $3.7 trillion came during the three phases of the quantitative easing program known as QE1, QE2 and QE3. In deciding how to deleverage, the Fed has two choices: (1) simply let bonds mature or (2) actively sell the bonds back to the market before maturity. It is widely expected that the preferred course will be to let bonds run off naturally and that the Fed may begin this process gradually this fall. The dual strategy of interest rate normalization and balance sheet reduction will be a difficult one for the Fed to execute this year and the pace of such execution will be watched by all. We view the potential for a policy misstep by the Fed as the biggest risk to future US stock price growth for the remainder of 2017.

As we reach the midpoint of 2017, we see a European economy on firmer ground after a grinding and uneven climb since the 2008 global financial crisis. Accelerating manufacturing activity, falling unemployment, easing deflationary pressures, corporate earnings growth momentum and improving business and consumer sentiment all point to a steadier mid-cycle expansion across the Eurozone. There is little doubt that Europe’s industrial sectors have benefited from the recovery in global trade and Asian growth, which suggests that the global economy is finally in a period of synchronized expansion. This cyclical upswing is in contrast to what we see for the US economy, itself in a more mature phase of the business cycle in which most asset valuations are generally high. Eurozone equities (STOXX 50 is +15.42% in 2017) continue to trade near historical lows. While political risks remain (including a now more uncertain Brexit path), we view the case for increasing exposure to European equities to be the strongest one we have seen since 2008.

Richard M. Welch, Jr.

President and Chief Investment Officer

(P) 215 603 2976

7/5/2017 rickwelch@academywealthadvisers.com