Returns for the major stock indices for the first half of 2015 are as follows:
|Dow Jones Industrial Average||-1.14%|
Year-to-date, the driving market forces for stocks and bonds have included both temporary and ongoing issues. The temporary issues hit largely in the first quarter of 2015, including an unusually cold and snowy winter for major portions of the country and a West Coast port strike delaying the normal flow of many goods. Like 2014, when harsh weather temporarily held the economy back, we expect forthcoming economic reports will show growth lost in the first quarter will be recovered in the second and third quarters of this year. The West Coast port strike ended in mid-March and we expect its limiting effects are also being recovered.
Ongoing market driving forces include:
- Anticipation of Federal Reserve rate increases: Like many economists, we are expecting the Federal Reserve will raise interest rates later in 2015. This will be the first Fed rate increase in nine years. The timing of this increase is uncertain, but it is likely to happen this fall. While the media and many market followers continue to sensationalize the timing and importance of this Fed change, we believe the move is more symbolic.
With the Fed currently targeting near-zero short term interest rates and saying the timing of rate increases will be determined by economic strength, our view is any rate increase in 2015 is cause for optimism. We feel a rate increase will be signaling the Fed believes the economy is finally strong enough to handle higher interest rates. Also, at this point, any increase in short term rates only means the Fed will be marginally less accommodative. It will take at least a couple years of rate increases, likely longer, before the Fed will begin to approach a non-accommodative or neutral posture.
Rather than focusing energy on the timing of the first rate increase, we believe it would be wiser to think about the possible tempo of future rate increases. In previous periods of Fed tightening, they have generally tightened steadily, often following their meetings. While starting at a base level of near zero may give the Fed room to tighten steadily following each of their eight annual meetings, we believe the Fed will likely tighten less frequently. Given their “data dependent” statements, we think their tightening tempo will be slower and more gradual, especially over the first 12 to 18 months. A pattern of tightening after every-other meeting seems probable to us.
- Will Greece default on its debt?: The possibility of Greece defaulting on its debt has been in play since 2009. We do not believe this issue is worthy of the significant market moving status the media has given it. As this letter goes to print, we believe an eventual Greek default is probable; however, it is likely such an event will resolve in similar fashion to the default of Detroit in 2013. It will initially come off as a big deal, but it will not signal the collapse of the European economy or the breakup of the Eurozone. Respectfully, Greece is a small country, even within the European Union, and its long term impact on Europe and the rest of the world will be minimal once the initial headlines fade.
- How are corporate profits doing?: A year ago, before energy prices fell, energy related stocks totaled 10.9% of the S&P 500’s market cap. Today, energy sector companies are just 8% of the S&P 500 index and represent just 3% of the index’s total profits. While this has led to a slight decrease in overall S&P 500 earnings, we are encouraged by how non-energy company earnings (the other 92% of the index) have risen by an impressive 11.7% from this time last year.
Looking ahead into the second half of 2015, we remain optimistic. Year-to-date we have seen parallels between 2015 and 2014 when mid-year returns were held back by weather related economic challenges in the early months of the year, only to later blossom in the fourth quarter.
Giving us added optimism is the continuing expansion of job growth and personal incomes. This leads to expanded consumer purchasing power in an environment where household debt ratios remain at low levels not seen since the 1980’s. Likewise, corporate profit margins are high, balance sheets are loaded with cash and business growth metrics suggest the need for further business investments, which have historically been a healthy sign for the economy and markets.
None of this means equities are as attractive today as they were in March of 2009. Nor does it mean we will not have typical market corrections. However, the investor with a long-term perspective should enjoy reasonable and attractive returns over at least the next couple of years because the bull has further to run. True bear markets are typically the result of recessions and those ingredients are not currently in the recipe or even on the horizon.
As we frequently say, we welcome and encourage you to call and schedule an appointment to review your assets under management at LYNCH & Associates. We certainly appreciate the confidence you place in us and we strive each day to maintain your trust and exceed your expectations.
Ryan T. Lynch, CFP® ChFC®
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