The First Seventy Days
During the first seventy days of the Trump administration, the President took aim at several initiatives with little success. The executive order on immigration and healthcare legislation were both unsuccessful, and Wall Street is taking notice. The market started to shed the “Trump Trades” shifting from the banking and industrial stocks to more growth oriented companies within the technology sector. For the quarter, the Dow ended up 4.56%, the S&P 500 up 6.07% and the international markets as measured by the MSCI EAFE index finished the quarter strong up 7.25%.
As discussed in our last newsletter, the market is always forward looking and just after the election, started to price in the three main policy initiatives: the repeal and replacement of Obamacare, the repeal of the DOL’s Fiduciary Rule and the infrastructure spending funded through tax reform. On March 24th the Republican driven American Health-Care Act (AHCA) was pulled from a vote as the House concluded that they did not have the needed votes to pass the legislation. If Trump cannot pass the healthcare legislation with GOP control of both House and Senate, will he be able to muster the support necessary for infrastructure spending and tax reform? Investors are concerned about the other initiatives, which is why the markets sold off in response to the AHCA.
The Fed Speaks
True to her word, Janet Yellen and her team at the Federal Reserve decided our economy is improving enough to warrant not only the rate rise we saw in December, but an additional one in March. The meeting minutes indicate that the Fed may raise rate two more times before the year is over.
To recap, the Federal Reserve is charged with a dual mandate over employment and inflation. The current unemployment rate is relatively low at 4.7%, the strongest in years (unemployment hit peak of 8.5% in 2012). There is an issue with under employment but those type of issues are not reflected in the main headline figure. With unemployment low, the Fed is turning its attention to inflation. The economy is trending right on track with the Fed’s target of 2% inflation, with the recent data at 2.2% (annualized). To control inflation, the Fed uses interest rates and in some cases authorized the purchases of government debt. If inflation increases, the Fed can accelerate rate increases to incentivize consumers to save vs. spend, curbing inflation.
The recent meeting minutes also outlined the strategy to unwind the bond purchasing program, also known as the Quantitative Easing (QE). The Fed became one of the largest buyers of our debt during the midst of the financial crisis. Currently, the Fed is holding $4.5 trillion in Treasury securities and mortgages. Over the past several years as the debt has come due, the Fed decided it was best to “roll” the debt (repurchasing more mortgages or Treasuries with the proceeds of matured securities). This allowed the Fed to lower rates even further to stimulate the economy.
Well, it looks like the end of QE is here. Going forward, the Fed will hold off from rolling the debt and actually retire the money supply from the system. This could put further pressure on rates, both mortgages and Treasuries. Though in previous QE programs, rates have actually decreased when the program ended rather than increase. We shall see if this time is different. We anticipate that the Fed will be moving very cautiously and will be closely working with policymakers on how to proceed. If rates continue to rise, we will be shifting the bond strategies to minimizethe impact.
Brexit
Brexit is officially underway. The formal exit of the British from the European Union started at the end of March with Article 50. This exit is expected to take two years and will involve many negotiations between the United Kingdom and EU. We anticipate that this will be a very rocky road. The EU has already ruled out a trade deal with the UK until the formal exit has been finalized. The guidelines for the exit must be approved by the remaining 27 countries by their April 29th summit meeting. It’s estimated that the UK will owe roughly $54B USD to the EU to cover for their share of the financial commitments and contingent liabilities should a large number of EU banks fail.
Scotland’s referendum will be back on the calendar. The Scots will get to vote again on leaving the UK. Scotland overwhelmingly voted against Brexit in 2016. With Article 50, there is a strong possibility that the independence referendum will pass and Scotland will leave the UK to join the EU, dealing a double blow to the UK economy.
If you're planning a trip to UK or Europe, now is a great time to go. Take advantage of the strong US dollar.
Here Comes the Sun
As we enter into Spring we welcome the change of pace, the shorter nights and of course the sun. Like most who enjoy the outdoors and the sun if you are not careful you will get burned, literally. With the US markets hitting new highs we are watching the technical, fundamental and political sides of the spectrum carefully. We too enjoy a few rays from the sun, but we don’t want to get burned. When the time comes and volatility rears its head again, we will seek to reduce risk or hedge portfolios where appropriate. Until then, let's put on our shades, lather up the Coppertone and enjoy the sun while it lasts.
As always, if you have any questions or concerns please give us a call. Be sure to follow us on Facebook, LinkedIn and Twitter as well as our RSS feed to stay up to date on what we’re reading and thinking.
Eric Lai and John Wenzel
Eric Lai & John Wenzel | Archvest Wealth Advisors