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U.S. & World Economy by Mark:

Irrespective of the news “noise” and saber rattling, the fuse has been lit for the “Trump Trade” once again. Over the last 4 – 6 weeks U.S. focused stocks, interest rates and the U.S. Dollar have all surged from the doldrums. As we head into the historically volatile month of October, the U.S. economy is finally achieving a 3% GDP growth rate (second quarter revised) and the financial markets are strong. Hopes are gaining for a Federal Government tax reform, which comes at a good time for us Californians who have the highest state income tax, sales tax, gas tax and vehicle tax in the country (according to the Orange County Register). However, our ability to offset these taxes against our federal taxes will be a major battle. As we wrote in our January 2017 newsletter, we believe lower taxes will again help GDP growth and, surprisingly, help with Federal Government deficits as they have done in the past.

While inflation has stubbornly remained below the 2% Fed target, interest rates have started moving upwards in anticipation based on our low unemployment level, increased GDP, pro-business agenda, hopes of tax reform, and the impact of the Fed starting to sell off their $4 trillion holdings. Time will tell if this is the start of a multi-year trend or another false start. 

U.S. & World Economy by Mark:

Economy: The Trump “sugar rush” is over, yet we have landed on an economic sweet spot for inflation (approximately 2%). This combined with modest worldwide GDP growth, near full employment, and cautious hope on tax reform has lead global financial markets (both stocks and bonds) to end the first 6 months of 2017 with near YTD highs. Surprisingly, we’re also in a climate of lower volatility than one would have expected – the lowest in 50+ years according to Wall Street Journal – given the drama highlighted by the “news” and the media. However, first half of the year bets on higher inflation and domestic company growth have gone unrewarded as commodities (led by oil), managed futures, and small cap stocks have all underperformed this year so far.

By year-end we suspect that this current economic balancing act will have selected a specific direction: either there will be a belief that pro U.S. business policies will start (and work) and inflation/higher interest rates will resume; or hopes will peter out and our flattening yield curve (combined with high valuations) will lead to the next downturn in the economy and financial markets. We are not willing to make that “all or nothing” market call and thus we remain well balanced and positioned to accept either outcome.


U.S. & World Economy by Mark:

While the upticks in both U.S. sentiment and the stock market are in part a reflection of the optimism over President Trump’s pro-growth plans, there is more to the story. The other main contributor is the collective recognition that we finally have a moderately growing global economy with few weak spots. The U.S. was the cause of the global financial crisis of 2008, the first to bottom and the longest to recover. The rest of the world’s GDP expansion has been years shorter and is still catching up to our higher valuations. Secondly, after five quarters of Wall Street corporate profits dropping (the last quarter was 3Q2016), the first and second quarters of 2017 look positive with a deliberate buildup of inventories on optimism. However, that is largely behind us now as the financial markets often project six months or more in advance. The failure to address Obamacare – even with a Republican majority – makes the rest of Trump’s business-friendly agenda much less certain leaving global growth as the remaining reason for bullish optimism. We expect the markets’ sentiments have shifted from “tell me” to “show me” which will cause the financial markets to back and fill until the second half of 2017 becomes clearer.  

1Q2017 Economic Update
January 6, 2017: 1Q2017 Economic Update

Trump/Economy
A large part of Trump’s political capital will be used to rewrite the tax code to lower personal and corporate tax rates and limit deductions (besides replacing Obamacare, increasing infrastructure spending, rolling back excess government regulations and probably a little tightening on immigration and increased nationalism to give red meat to his constituents). Therefore, an initial assumption would be to expect lower tax receipts and rising government budget deficit after the proposed tax cuts.

However, upon reviewing the most recent large tax reductions in history (under President Kennedy, President Reagan and President Clinton specifically), it appears the opposite occurred. Under President Kennedy, tax revenues increased 62% from 1961 – 1968, unemployment went from 5.5% down to 3.9%, and the stock market doubled. Under President Reagan, tax revenues went up 99% throughout the 1980s, unemployment peaked at 10.8% in 1983 then dropped to about 5.8% in 1990, and the stock market tripled. Under President Clinton, tax cuts in 1997 led to a 59% gain in tax revenue, eventually producing a budget surplus of $198 billion by 2000, unemployment continued down from 5.8% to under 4%, and the stock market doubled from 1997 – 2000.

In all three of the above cases, citizens in the top income tax bracket felt an upsurge in their share of the tax burden (lower % but higher $) while real wages grew across the board. The heart of the problem is declining median income and this directly contributed to Trump’s popularity in the recent election. The average U.S. median income of $57,423.00 in 2007 dropped down to $53,718.00 by 2014 while the top 10% of income earners grew. It is Main Street’s hope to gain real wage increases again. 

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The Volatile Path Back to “Old Normal”

After 2 weeks of absorbing the U.S. election results, watching the financial markets and reading countless market and economic commentaries, we offer the following condensed thoughts.

What was Expected?

While the election was thought to be close, the odds makers and thus the financial markets were clearly expecting a Clinton victory. That meant continued heavy entitlements, higher taxes, very low GDP growth, low inflation and a decent chance of a recession in 2017. All of this led to ultra-low interest rates and a relatively high stock market based on no real alternatives for positive risk based returns.

What Happened?

But Trump won. Now if, and a big if, Trump’s Republican-led houses get their way, we will see lower taxes (lower personal and corporate taxes and no 3.8% Obamacare tax), less regulation and all manner of fiscal stimulus that has so far been absent in our weak recovery over the last eight years. This would lead to higher GDP, higher wages, no recession and eventually higher inflation. The new premise is that we are headed back to the “old normal” of 3-4% GDP, 3%+ 10 year government bonds and higher corporate growth rates. Therefore, valuations multiples would also “normalize” with lower P/E ratios and higher cap rates for real estate.

4q16-newsletter-header

Financial Markets Review by Mark:

U.S. and World Economy

The calm before the storm. Developed world financial markets (U.S., Japan and Europe) have become numb to the long-term effects of unprecedented monetary stimulus. The companies in the S&P500 are now reporting their 6th quarterly drop in revenue and 4th quarterly drop in corporate profits. The labor recovery peaked 8 months ago (job openings and unemployment) as weak hiring is catching up to weak GDP growth. After a 1% revised first half U.S. GDP growth, the second half of the year was supposed to bounce back – it has not. Yet both stock and bond markets remain near all-time highs amidst very low (by historic standards) volatility. The developed world stock markets have benefited from very low cost borrowing to facilitate share buy-backs, artificially creating higher earnings per share; bonds have benefited from Central Bank buy-backs as well.

However, these monetary maneuvers may have peaked this summer. Since then, interest rates have moved higher and the stocks which moved highest the first half of the year have dropped the most in the second half (REITs, utilities, tech). In addition, near-term election cycles here and in Europe have raised the voice of nationalism, border and trade protection. There is talk of “Italeave” ala “Brexit”. We believe that the next major downturn will start in Europe where low and negative interest rates have pulled business forward as much as possible, bringing the weak economic expansion to an earlier than expected close. Initially, the U.S. will be the beneficiary of a flight to quality, but a stronger Dollar set against a falling Yen and Euro will hurt our exports and lead to our own recession.

3Q2016 Optivest Newsletter
Financial Markets Review by Mark:

U.S. Economy
The steep drop in financial markets early in the year aggravated fears of a near-term recession. Since then the markets have rebounded allowing fears to subside, yet we now have warning signs from the U.S. economy itself. Hiring is weak, sales are slipping and new business investments are dropping. Manufacturing remains weak and corporate profits have not gained ground in 3 quarters. All of these are classic signs of an impending economic downturn. Uneven economic growth throughout our 7-year expansion has given us several such scares in the past. The latest excuse is to blame slow growth on the rest of the world: i.e. America would be booming if not for China, which would be booming if not for Europe, which blames Japan, which in turn blames America. With uncertainty increasing from Brexit and U.S. election cycles, we continue to forecast a recession in the next 12 – 18 months.

Brexit
Much has already been written and read concerning the “Brexit” decision on June 23rd. It caught the financial markets off guard and sent equities and commodities down (except gold) as bonds and REITs went up; then we had a quick reversal. It is very hard to plan for binary outcomes (i.e. heads or tails scenarios), however our “all accounts composite” only dipped 5 basis points between the time of the vote and second quarter-end. Our low equity exposure and larger real estate and alternatives allocations resulted in continued gains for the year, despite a weak stock market. 

2016 Economic Update

Financial Markets Review by Mark:

First Quarter 2016 Review –
What a wild first quarter! After the stock and corporate bond markets had one of the steepest sell-offs during the first 7 weeks of the year (and the S&P 500 was down over 10%), the markets rebounded to end the quarter virtually unchanged for the year. As frustrating and scary as this was, Optivest clients were aided by our defensive start, purchases on dips and continued advances on our REIT holdings, which collectively resulted in one of our best quarters ever.

U.S. Economy –
The year started off with one of the biggest “false alarm” market scares in years. Worries increased about global slowing/recession, deflation, Chinese devaluation, falling profits, excessive emerging market debt and corporate defaults due to cheap oil. The usual “safe haven” investments – gold, U.S. Treasuries and Swiss Franc – rallied, gaining momentum born from fear. Finally, oil appeared to bounce at about $28/barrel enticing “bottom fishers” who first gave the equity and commodity markets a push, then a retest of the bottom, followed by a 7 week rally ending right back where they started the year. “Safe haven” price gains have held while all of the worries remain, indicating future volatility.

Optivest Economic Update

Financial Markets Review by Mark:

2015 Economic Review –
World markets have been caught between two strong forces: 1. the Federal Reserve’s desire to increase interest rates as a result of an improving U.S. job market, and 2. weakening economies in the rest of the world as a result of China’s deceleration, bringing commodity prices to multi-year lows. The result produced a volatile tug-of-war causing U.S. markets to deliver the worst year since 2008 after dealing with a soaring U.S. Dollar, sinking junk bonds, low yields and crashing oil prices.

Outside of the F.A.N.G.s (Facebook, Amazon, Netflix, and Google), U.S. stocks struggled all year, commodities and emerging markets dropped in sync, liquid alternatives faltered (average hedge fund was down 3%), and old European markets advanced thanks to a devalued Euro and heavy Central Bank stimulus. Interest rates rose, leaving most bond funds with either small gains or losses (including income). 2015 was quite a frustrating year for investors as there were few winners and multiple losing asset classes.

Optivest 2015 Mid-Quarter Market Update

Economic data at mid-quarter is quite mixed. On the positive side: the U.S. stock and bond markets rebounded back to beginning of the year levels; hiring was up in October; and the third quarter GDP was revised from 1.5% up to 2.1%.

On the negative side: consumer sentiment hit a 15-month low this week (on November 24, 2015); the stock and bond markets saw a very narrow rebound mostly from the “FANGs” (companies like Facebook, Amazon, Netflix and Google with high P/E ratios); and revenue and profits for the S&P 500 are headed toward decline for the third quarter in a row. This combination of activity has raised the P/E level of the S&P 500 up to 23 from the 20 level we witnessed over the summer (the long-term average is 15.5%). These mixed signals force us to maintain a cautious stance, avoiding U.S. equities until fundamentals improve.