|BKD’s Top Three
Check out our economic and market highlights for top takeaways from this Q2 market update.
- From tax cuts to increased infrastructure spending, potential policy changes could benefit the overall economy.
- The market is experiencing one of the longest expansions in history, but the data doesn’t point toward a recession.
- International stocks have improved this year, while alternatives have been weak.
For more insight, read Jeff Layman’s expanded marketing insight and quarterly commentary below.
As we hit the midpoint of 2017, the second quarter fared well for stocks as they climbed higher, and market volatility fell to the lowest level in 10 years. The U.S. economy continues to move at a similar pace to that of the past several years. First-quarter GDP growth was 1.4 percent, and estimates for the second quarter are in the range of 2.5 percent to 3 percent. This follows the pattern of a weak start followed by improvement in the remaining three quarters. International markets were strong, producing double the return of U.S. shares, while bonds and alternative investments produced modest returns.
Expected Policy Changes May Breed Growth
An anticipated policy change is the reduction of individual and corporate tax rates. Legislation has yet to be passed, but the administration has indicated it intends to pursue tax reform. As such, the potential economic benefits of tax cuts and other initiatives—like increased infrastructure spending and less regulation—still lie ahead. The prospect of lower tax rates continues to have a positive influence on stocks.
A Recession Is Unlikely
The economy is experiencing its third-longest expansion in history at 96 months, which may suggest we’re due for a recession. However, the Conference Board Index of Leading Economic Indicators (LEI) continues to hit new highs. A recession is unlikely because the U.S. economy hasn’t historically entered recession until several years after the LEI peaked. The pace of economic growth during this expansion has been unusually slow, which may cause it to last much longer than previous expansion cycles.
International Equities Edge Higher While Alternatives Remain Tepid
For the last few years, foreign stock markets have lagged U.S. market returns, but this is changing. Strong year-to-date international market performance is driven by improved economic growth, attractive valuations and dividend yields and improving currency strength against the U.S. dollar. The global economic expansion is better synchronized across regions and countries than at any point since 2009. This should support improved international stock returns going forward.
On the other hand, we’ve seen below-average returns from alternative investments. These types of assets are designed to do well when other parts of the portfolio aren’t doing as well. Returns have disappointed despite alternatives allocation providing the desired risk benefit in recent market downturns. Low market volatility and the low interest-rate environment, as well as the reduced investor emphasis on risk management in the latter stage of the bull market, are contributing factors to weak performance. With that in mind, maintaining an allocation to alternative investments with strong diversification characteristics makes sense at this point in the market cycle.
Expectations for the Rest of 2017
Global stock markets have produced a full year’s worth of return in a six-month period. Year-to-date balanced portfolio results are close to the average return assumptions used in our financial planning work. That said, returns in the second half of the year won’t likely be as strong.
Fortunately, the global economy is growing, and profit trends are improving. When these conditions are in place, the risk of a major stock market downturn tends to be low. With stretched valuations in the U.S., earnings growth will be important for stocks to move higher in the second half of the year. International stocks should benefit from similarly positive economic and profit trends but offer better upside potential due to more appealing valuations. Maintaining a healthy allocation to foreign stocks should prove beneficial for investors.
The Federal Reserve’s two rate hikes so far this year didn’t hurt financial asset prices, as many feared they would. Rising interest rates typically have a negative impact on both stock and bond prices in the short run. But rates have been kept artificially low for several years. Therefore, the Fed’s recent actions have been viewed by investors as more of a normalization process than a threat. Our base assumption is that interest rates will drift moderately higher in the second half of the year as inflation stays in check due to modest economic growth.
Time will tell whether events will materialize in the second half of 2017 that will increase risk. Investors can protect themselves from uncertainty by maintaining diversification across various asset classes and investment strategies. While we expect some bumps along the way, 2017 is shaping up to be a reasonably good year for investors.
Jeffrey A. Layman, CFA®
Chief Investment Officer
BKD Wealth Advisors, LLC is an SEC registered investment adviser offering wealth management services for affluent families and investment consulting services for institutional clients and is a wholly owned subsidiary of BKD, LLP. The views are as of the date of this publication and are subject to change. Different types of investments involve varying risks, and it should not be assumed that future performance of any investment or investment strategy or any noninvestment-related content will equal historical performance level(s), be suitable for your individual situation or prove successful. A copy of BKD Wealth Advisors' current written disclosure statement is available upon request.