Second Quarter Investment Commentary

Second Quarter, 2017 Investment Review
Change
“It is better to know some of the questions than all of the answers .”
– James Thurber
Change! Weather, employment, relationships, health,
politics, stocks, inflation, life – all change; some
seasonally, some gradually, and others unexpectedly.
Is it windier this year than last? Warmer? Is the political
rhetoric louder? Is Washington less effective? For answers to
those questions look elsewhere. For investment insights, read on.
Stocks continue to climb a wall of worry, bonds remain
richly valued. Stocks in most developed markets continued their upward
march in the first half of 2017. International developed and
emerging stock markets outperformed, in part reflecting
a modestly weaker U.S dollar. Positive results also reflect
relatively steady economic progress both domestically and
abroad. The S&P 500 index rose 2.6% in the second quarter
and is up 8.2% year to date as of June 30. The MSCI World
Index and the MSCI Emerging Markets index returned 3.4%
and 5.5%, respectively in the quarter ended June 30, 2017.
Year to date through June 30 they rose 9.4% and 17.2%,
respectively. Are they too high? This question is always asked
in up markets as investors brace for anticipated pullbacks and
corrections. Timing such inflections is impossible – hence the
climb over a “wall of worry” (as investors fret over economics,
growth). In a slow growth, low interest rate world we argue that
current valuations are not (yet) excessive. Price/earnings
multiples for the S&P 500 Index are 21.4 times (x) trailing
earnings and 17.6x next twelve months’ estimated earnings
–above long term averages and not cheap. Consequently, we
are targeting below average risk within our client’s investment
policies. Bond yields are lower than year-end 2016, even after two
Federal Reserve rate hikes in 2017. The ten year yield
reached a low of 2.12% mid-June before spiking up to close
June at 2.30%. Global bond yields also rose sharply from low
levels in late June. The U.S. yield curve “slope”
flattened modestly in the quarter as rates on bonds maturing
within one year rose and yields on longer date bonds
dropped. The yield curve (yields plotted against maturities)
is still upward sloping – a flat curve is often accompanied by
recessions. Oil prices extended their weakness until the last week of June
when they recovered 7% yet closed the quarter at $46.00/
barrel. Down from $50.60/barrel at March-end. Gold prices
were little changed at $1,242.00/oz.
Economic Fundamentals
U.S. first quarter 2017 economic growth was a seasonally
weak 1.4%. It is expected to surpass 2% for the second
quarter and continue over that level in the second half of
the year driven by a rebound in consumption. Domestic
employment and housing remain steady: unemployment
at 4.3% and average home prices up 5.8% year-over-year
through May, 2017. U.S. job openings are at record levels
but wages are not yet rising.
Economic Fundamentals
U.S. first quarter 2017 economic growth was a seasonally
weak 1.4%. It is expected to surpass 2% for the second
quarter and continue over that level in the second half of
the year driven by a rebound in consumption. Domestic
employment and housing remain steady: unemployment
at 4.3% and average home prices up 5.8% year-over-year
through May, 2017. U.S. job openings are at record levels
but wages are not yet rising. After trending up in 2016, inflation has reversed itself
in 2017. Explanations include the weakness in retail
employment and lower energy prices. We suspect that
productivity improvements and the shift to internet services
are also contributing to a lower, and later, labor inflation
picture.

Outlook
U.S. stock price to earnings multiples have expanded
significantly over the last three years in a slow growth
economic environment. This is, in our opinion, unsustainable
in the long run. Significantly higher stock market returns over the next few years
will likely require higher earnings and faster economic growth.
Successful tax reform, favorable repatriation of overseas earnings
for U.S. companies, and higher infrastructure spending may
be important contributors to the upside case. Our base case
continues to be more cautious; moderately accelerating earnings
growth partly offset with flat to declining price/earnings
multiples. Rising interest rates are also likely over the next two
years but are far from presenting serious competition for stocks.
We will continue to diligently track developments and endeavor
to identify meaningful changes.

Thank you for allowing us, your Regency team, to ask the right
questions on your behalf as we assist you in achieving your
financial goals. Please call us to share any thoughts, concerns,
or insights.

Please call us with any questions .

Andrew M. Aran, CFA
Mark D. Reitsma, CFP®, CMFC
Timothy G. Parker, CFA
Bryan D. Kabot, CFP®, AAMS®

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