On the Horizon: Seven Focus Areas
In a Nut Shell: It is unlikely we’ll have another calendar year like 2017 where broad markets experienced both historically low volatility and strong, abnormally consistent returns. It’s impossible to tell when or what will drive an eventual increase in volatility, but there is never a shortage of events or areas for investors to keep an eye on. As long as these lists often are, if 2017 has taught us one thing, it’s that markets will choose to look through geopolitical drama so long as global economies remain on solid footing. Strong growth that results in excessive inflation could still be problematic, so to borrow the Goldilocks theme from our previous quarterly commentary we ideally want the “not too hot, not too cold” economy to continue.
For insights on each of these seven focus areas, read below.
We introduced this section several quarters ago as a way to highlight and discuss some of the potentially market moving events, news, and concerns of the day and coming period. This is not meant to be an all-encompassing list and of course there will always be unanticipated developments that impact markets. In our comments we also attempt to gauge what the market may be anticipating given that markets typically place their bets ahead of any announcement or resolution based on what it believes the likely outcome is. Therefore market reaction to a resolution is often more a result of how far off investors were in their prediction.
The past two quarters lists included several items worth repeating from an ability to move markets, but in several cases the facts and circumstances are little changed. Rather than rehash worries regarding North Korea, China or Brexit, we thought it would be more interesting to highlight a few different areas and provide our thoughts.
- Global Economy – if one thing has become clear over the last year it’s that the geopolitical drama that drives our 24 hours news cycle takes a backseat from a market standpoint as long as the global economy is on solid footing. Since mid-2016 there has been a noticeable pickup in activity around the globe and that activity accelerated during the course of 2017. The term du jour among Wall Street investment strategists is “synchronized global expansion”. The breadth of growth is impressive and the consensus among economists is that it will continue into 2018. While that is certainly a good thing, it does also raise the risks related to a disappointment on that front.
- Tax Reform – The ink is not even dry yet on the massive tax reform package that was approved in late December (see Smith & Howard’s summary here), but accountants are already busy combing through the lengthy bill and attempting to better understand how their clients will be impacted. Even if one of the administration’s goals was simplification of the tax code, there is still quite a bit to decipher and individual and corporate taxpayers may not know for some time exactly how this is likely to affect their specific tax situations. Economists will also be busy projecting out the impacts of the reform and dissecting every bit of data as it becomes available. A lot is riding on the reform, so expect that analysis to receive plenty of media attention and market impact. Given our ongoing connection with our founding CPA firm we’ll be providing some of our own thoughts, so stay tuned for that in the near future.
- Regime Change at the Fed – with the promotion of Jerome Powell to Chair, six of the seven board members will have been nominated by the Trump administration when the process is complete next year. There is a clear changing of the guard, not just with regard to the individuals involved, but also because many of the outgoing members shared similar economic beliefs and viewpoints. The new board at a minimum will take some time to settle in, but is also very likely to include a more diverse set of views and backgrounds. What this means for rate decisions and guidance is impossible to know at this point, but markets typically dislike uncertainty and change. This happens to introduce a lot of both.
- Inflation – While there are currently no signs that excessive inflation is on the horizon any hints that it could be would be a significant event. Low global inflation has been one of the biggest factors allowing the continuation of accommodative monetary policy. That accommodative monetary policy has in turn driven higher asset prices in both stocks and bonds. As we noted in item 3 above, there will be significant turnover at the Fed, but their mandate and inflation target will most likely not. A pickup in inflation figures or fears would likely lead to a faster removal of the easy monetary policies across the globe. It’s been a long time since we’ve seen significant inflation and the market is not currently pricing in much risk related to it.
- Russia Investigation – The ongoing Mueller investigation has the potential to drive markets, but the direction is uncertain. As stated in our comments about the Fed, the market typically dislikes uncertainty. Were the investigation to force out key administration members, the market would likely perceive this as a negative event. This would depend somewhat on how “key” those people are. A lengthy process putting the President himself at risk would undoubtedly spook market participants. The administration has pushed a pro-business agenda, so anything jeopardizing or delaying key initiatives would be a disappointment. An exoneration of the administration, however, could clear the air and remove the overhang.
- Volatility – We’ve highlighted several times in other sections just how unique the low level of equity market volatility was during the course of 2017. While the other items in this list all have the potential to increase volatility in the market, could the low level of volatility itself be a concern? The historically low volatility has undoubtedly resulted in some level of what we’ll call “equity creep”. Equity market selloffs or drawdown, while unpleasant in the short term, are a good reminder that markets may be volatile and it is possible to lose money. Without those fear-inducing pullbacks, investors often become overconfident and complacent letting their allocation to equities “creep” higher. The longer the period of time with low volatility the greater the “creep”. This will only be evident when volatility finally does present itself, but it could very well result in an abnormally sharp drop in equities as it unwinds.
- Bitcoin and Cryptocurrencies – We cover Bitcoin and other cryptocurrencies in our A Deeper Dive section, but as the euphoria related to cryptocurrencies spreads across the broader global investing population, the potential for spillover increases. As gains in cryptocurrency prices accelerate, the probability of a significant pullback increases and the potential for collateral damage to stock and bond markets shouldn’t be ignored. Those markets may not be big enough yet to have much direct economic impact, but market sentiment would undoubtedly be impacted.
If it feels like the above list is full of more potential negatives than positives, it is likely an outgrowth of the lengthy bull market we’ve enjoyed and our nature to be on the lookout for destabilizing news or events. There remain a number of positives that investors can point to that can support markets and potentially even drive them higher. The synchronized global growth story is expected to continue for good reason, tax reforms in the U.S. are likely to provide further near-term stimulus, inflation remains low, employment levels continue to improve, and innovation in areas such as robotics and AI (artificial intelligence) are creating new investment opportunities every day. There is still much to be excited and positive about as an investor even if we need to temper our return expectations due to valuation levels.
For more information on how these seven focus areas affect our investments strategy, please contact Brad Swinsburg 404-874-6244.
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Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.