US stocks continue to do well on a week to date, year to date, one, three and five year basis as shown below
Bonds have had modest positive returns year to date which is not bad given a rising interest rate environment. Bonds tend to fall in value when interest rates rise.
Why are stocks rising? Stock prices tend to follow corporate earnings and according to FactSet, the blended earnings growth rate for Q1 2017 is 12.5%. If that number holds through earnings season, it will mark the highest year over year corporate earnings growth since Q3 2011. Currently, 58% of companies in the S&P 500 have reported earnings and 77% have beat the mean earnings estimate. 68% of companies have beat their sales estimate. Below you will see flat earnings and thus flat stock prices in 2014, 2015, and 2016. Currently, 2017 and 2018 corporate earnings estimates are looking positive.
Recession Indicator: Yield Curve
One of the biggest enemies for stocks is a recession. When our economy contracts during a recession, earnings tend to contract for many companies and stock prices fall. One measure that has been a reliable indicator of past recessions is a negative yield curve. Notice how the blue line (yield curve) turns negative before each recession (shown by the grey bars) dating back to the 1970’s. Currently, the yield curve is positive and well above the zero mark (black line). This indicator shows no sign of recession at the moment.
Recession Indicator: Leading Economic Indicators
Another measure that signals recession is leading economic indicators. Below, you see a chart from The Conference Board showing leading economic indicators for the US in blue. Current economic indicators for the US are shown in red. Notice how leading indicators tend to turn down before the last couple of recessions shown in grey. Current economic indicators follow. Again, not much sign of recession yet.
The US Federal Reserve has two primary jobs: maintain full employment and control inflation. You can measure employment many ways. The U3 unemployment number is the official unemployment number in the US. Many discount official unemployment figures by arguing that they don’t include discouraged workers and part time workers. True. The U5 unemployment number includes discouraged workers, meaning those that took a lower paying job but would have preferred something more. The U6 unemployment number adds discouraged workers plus those who are part time but would prefer full time work. No matter how you cut the numbers, unemployment rates in the US are near multi decade lows. Said differently, we are near full employment and when our citizens have jobs, that is good for the economy.
So with the economy chugging along nicely, the Fed is concerned now with inflation. Inflation means rising prices and too much inflation is bad. It erodes the value of our savings and our income. It is particularly damaging for retirees on a fixed income. Just as there are many ways to measure unemployment, there are many ways to measure inflation. One way is to take a basket of goods and compare the prices of that basket of goods over a period of time. This is known as the Consumer Price Index and it is depicted below going all the way back to 1920. As you can see from the chart, the Fed has done a pretty good job of controlling inflation in the post 1985 timeframe. We are currently at 2.4% price increase year over year as of March.
Below is a five year chart of the S&P 500, this shows that stock prices for the largest 500 companies in the US continue to trend upward.
Yet the stock market can react emotionally. Many market participants worry about any possible threat. Short term traders will try to anticipate and take advantage of these short term swings. Imagine if you tried to successfully time every little up and down in the chart above. Good luck with that!
Yet some of these threats are real. In my mind, the following are potential threats to the market:
- Rising tensions between the US and North Korea
- The ability of the Trump administration to pass their tax proposal
- US health care legislation
- Infrastructure spending
- Government budget and national debt
These are just a few of the possible threats to the market. It is difficult to anticipate how each of these will play out and what the market reaction will be. An example how difficult it can be to anticipate the market reaction to a threat was Britain exiting the EU last year which sent the market into a 3 day tailspin only to quickly reverse course shortly thereafter. Trying to trade such an event successfully is probably impossible. The best approach in my opinion is to develop a long term investing strategy that matches your goals, risk tolerance, and time frame and stick with your plan.
Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. Past performance is not an indication or guarantee of future results