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3rd Quarter Commentary

October 2017 Commentary

Global economic growth is on the rise which has led to an increase in the MSCI World Stock Market Index by 15% on a year-to-date basis.   Global GDP growth is currently 3.2%, up from 2.5% last year.  The U.S. stock markets are up 11-15%, depending upon the index.   U.S. companies’ earnings should be up 10%+ in 2017 due to the rise in global economic activity, especially outside the U.S., and to the decline of the U.S. dollar. At the current time, US companies’ earnings are expected to rise 12% in 2018. For the most part, markets have not reacted to the political sparring in Washington D.C. and geo-political rhetoric between the U.S. and North Korea. The bull market appears intact for the time being. 

Are we due for a stock market decline of 5-10% (1,100-2,200 Dow Jones Industrial Average points)? The U.S stock markets’ valuation, as measured by P/E (price divided by earnings), continues to be high at 17.7x earnings compared to the 15-16x historical average.  This has been a continual theme for the past two years, while the market has climbed the proverbial “wall-of-worry”. The U.S. stock market periodically declines by 5-10% during most bull markets, but has not experienced a sharp decline since January 2016 when oil prices collapsed to $29 a barrel.  I believe the stock market is setting itself up for a correction considering investor optimism, high valuations, and low interest rates. Typically, when a negative surprise occurs with this backdrop, a correction is likely. 

Primary risks to our economy and stock markets: the reduction of the $4.5 trillion Federal Reserve balance sheet, and a tight labor market. The Federal Reserve (FED) built up a $4.5 trillion balance sheet of US Treasury and mortgage-backed securities as it was providing cash into the economy to stimulate growth. The FED is now planning to reduce the size of its portfolio to “normalize” its balance sheet.  In doing so, if interest rates rise more than expected the stock market may decline in anticipation of economic growth being constrained.

I continue to advise clients to invest in the stock market for the long term, while having sufficient cash and bonds in one’s portfolio to ride through the next bear market.  Although both optimism and complacency are in the air, we can expect to have a bear market and recession at some point in the future.  During the past 18 months, LWM has been adding “long short” investments to most of our clients’ portfolios.  These investments are designed to capture most of the market’s upside returns, while being exposed to only approximately half the risk of the market.

Rich Lawrence, CFA Managing Director

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Is Economic Growth On The Verge of Rising?

I ask if economic growth is on the verge of rising for a very specific reason. The stock market in 2016 is up 10% as measured by the S&P 500 Index, led by materials, industrials, financial and telecommunications stocks; and with health care and consumer staple stocks being the two worst performing sectors. In addition, gold and bond prices are on the decline. Please note: when bond prices decline interest rates are rising. This market behavior is classically associated with rising economic activity and certainly not indicative of the latter stage of an economic cycle.

1-2% Real GDP Growth

This market behavior may cause confusion to many, especially after nine years of economic expansion. Although the U.S. economy has been expanding, it has done so anemically with 1-2% real GDP growth. This compares to 6-8% annual GDP growth immediately after the deep recession of 1981 when the unemployment rate hit almost 10%. Then in the 1980s and 1990s GDP growth was 2-5% annually.

After eight years of so-so economic growth, corporate and consumer balance sheets are in good shape and not overextended as is usually the case when the economic cycle is nearing a peak. The U.S. government however continues to run deficits, and its share of GDP has expanded from 19 to 21%. Obviously our government has not had the will to curtail expenses, and its balance sheet poses risk to our economy and taxpayers.

A Republican President and a Republican Congress

What should we expect with a Republican President and a Republican Congress? The Trump campaign and policy initiatives were straight forward: reduce regulations; cut corporate taxes; increase infrastructure spending; renegotiate trade agreements, rebuild the military; and border control. These initiatives are pro-economic growth and the markets responded swiftly.
Some observers (pre-election) opined that the federal deficit would expand regardless of the election outcome. However Mitch McConnell (Senate Majority leader) stated last week that any corporate tax reduction must be matched with budget cuts to fully offset the revenue decline. So let the bargaining begin!

Higher Economic Activity

The stock market is an excellent economic predictor for six months, but that is about all. The market is expecting solid low-teen earnings growth in 2017, along with rising inflation and interest rates. If our government enacts policies of lower taxes and regulation the “animal spirits” of our country may finally be ignited resulting with capital investment and business formation. The result: higher economic activity.

Primary Market Risks

I envision two primary market risks as 2017 unfolds: saber rattling as we attempt to slow the transfer of U.S. wealth to China, and to a lesser extent a strengthening dollar.

As we all know we are in a $400 billion trade deficit annually with China. Why does this matter? Let’s “follow the money”. We sell China plenty of products, especially high technology and complex industrial products. China sells us a wide variety of products from low to high tech, most of which have a high labor content. There is a well know economic theory called comparative advantage that supports free trade. Essentially, comparative advantage stipulates that trading partners all win when each country produces that which they can produce most efficiently. And if trade balances are equal both trading partners win through sharing higher productivity.

Wealth Transfer to China

Our trading situation with China is far different. The regulatory environment of the U.S. and China could not be more different in term of labor laws, environment and market access. Our trade deficit with China has been running between $300 and $400 billion annually for the past few years, and is literally a wealth transfer to China. These deficits provide China with $300 to $400 billion of U.S. dollar currency which can be used to buy U.S. Treasury bonds, businesses or real estate around the globe including back here in the U.S. If this trade imbalance goes unchecked, we will see a slow but continued wealth transfer to China.

President-Elect Trump brought this issue to the fore and it is at the cornerstone of Trumps economic policy. I expect both countries will be pushing back against each other providing uncertainty and potentially stock market corrections. The good news is that both countries are economically dependent upon one another, so both economies will benefit greatly if trading activity remains brisk but moving back into balance.

Is economic growth on the verge of rising? Most indicators suggest our economy is gaining momentum. If you have questions about economic growth, financial planning, or would like to learn more about investment management advice offered on a fee-only basis, contact me Richard Lawrence at Lawrence Wealth Management LLC, a small, private investment firm. Phone 215-540-0896; email rich@lawrencewealthmanagement.com.

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Thoughts From a Money Manager on New Trump Policy Initiatives

The election cycle is over: FINALLY! The political rhetoric we all witnessed was divisive and very disruptive. Once a Trump victory was evident, global markets sold-off taking the Dow Jones Industrial Average (DOW) down by more than 700 points at 1a.m. Eastern standard time on election night; only to rebound swiftly with the DOW now up over 400 points (2%) since election day, prompting this post containing advice from a money manager.

We now have a Republican President and Congress, setting the stage for reducing Washington D.C. gridlock and enacting pro-economic growth legislation. The support Bernie Sanders, Gary Johnson, Jill Stein, and Donald Trump received indicate the country was ready for change, and change we received.

Policy Initiatives Impacting Financial Planning

There are three initiatives I will be monitoring as part of the financial planning I do for my clients:

  • Tax Reform: Corporate tax reduction to 15%? I don’t think so; although 20-25% may be realistic. This would put the US in a globally competitive position from a tax cost perspective. In addition, there are $2 trillion of corporate cash parked outside of the U.S. because of the 35% tax levy that would be applied, if repatriated back to the US. There has been discussion of a 10-15% one-time reprieve from corporate taxation if repatriated to the U.S. If funds are brought back to the U.S., I expect a significant portion would be invested here in the U.S, providing a welcome stimulus to our economy.
  • The Affordable Care Act of 2010 (ACA):  Will it be abolished? Although ACA’s policy goals of increasing insurance coverage and cost reduction were virtuous, its design and execution fell short. I am sure this public policy initiative will get immediate legislative attention, due to rising premiums and deductibles that are affecting so many people. U.S. healthcare expenses is the single largest financial liability we face and needs to be addressed quickly. Health care expenditures have risen from 13% of our economy in 2000 to the current 18%. If these health care expenses are not controlled, how will we ever rebuild our infrastructure and educate our children? Who knows if ACA will actually be “repealed”, but the act will be amended and reformed.
  • Regulatory Reform: Regulations are hard to define economically but businesses, especially small businesses, have held back hiring and investing due to the regulatory environment. Small companies have been the life blood of our economy’s growth, and will benefit if regulation is eased. President-elect Trump and Congress have stated clearly that the regulatory environment will be eased, and many regulations outright eliminated.

The stock market is anticipating corporate earnings to rebound in the current quarter, followed by double digit economic growth in 2017. If consensus earnings growth of 13% and 10% are achieved in 2017 and 2018, respectively, the market could advance 8-12% implying a 20,500 Dow! The DOW is currently at its all-time high, indicating confidence in our economy and earnings for the next six to 12 months. Gold prices are also affirming this sentiment as they are down 11% from the high in July 2016, and down 5% since the election. While we are cautiously optimistic about the stock market and our economy, we are also keenly aware of various headwinds, including rising interest rates and inflation, and the likelihood of the very normal periodic stock market declines (corrections) which are taken into consideration with any good wealth management strategy.

November 15, 2016
Rich Lawrence, CFA
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This market update includes data we believe to be accurate. However Lawrence Wealth Management (LWM) does not warrant or guarantee its accuracy. Opinions about the future are not predictions, guarantees or forecasts. Investing in stock and bond markets have risk that could lead to investors losing money.

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Investment Strategy Changes as Summer Doldrums End in September

Summer is typically a quiet time for the markets, but quiet doesn’t mean your investment strategy gets to take a vacation. This summer was remarkably quiet, with the exception of the June Brexit turmoil and vote. In August, the markets were more than a little sleepy  with average volume across all U.S. stock exchanges reaching at its lowest level in over a year. How do quiet summer months typically impact investors, and how is investment strategy impacted now that September is here and the markets are back from vacation?

Investment Strategy And Volatility

The stock market this summer has been trading between 17,800 to the 18,500, and recent pulled back slightly to 18,000. While summer is typically associated with a quiet market, the September to November period tends to be a market with volatility both on the downside and upside.

Liz Ann Sonders, chief investment strategist at Charles Schwab, provides some insight into what is expected at the end of a period as quiet as the summer we have just had.

“History shows subdued periods tend to be followed by a lift in volatility, and some weakness in returns.”

While volatility means greater stock price movement higher and lower, most investors use this term when discussing downside risk or a market correction. For more insight, you can read her complete Market Perspective Report from September 2, 2016.

Adding Investments

We review your accounts regularly, and officially every month. We have been adding investments to clients’ portfolios with hedging strategies. These strategies are designed to temper downside risk while still participating in market advances. We are also shifting portfolio weightings toward growth stocks and mid-sized companies. These mid-sized companies tend to be takeover targets, are domestic oriented, and grow faster than their large global competitors.

We expect the market to be volatile in the next few weeks and market advances limited until a new President is sworn into office. Washington politicians are focused on securing power bases and getting re-elected. Any significant regulatory or tax reform will not occur until this election cycle is complete. If you have questions or concerns about the election cycle and your investment strategy, consider joining us for our October Investment Strategy Event, The Election Cycle and Your Investments.