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Ask the Investor: With the stock market up almost 9% year to date, what should investors expect for the remainder of the year?”

By: Ryan T. Fulmer
Friday, June 2, 2017

Last December I wrote about the top two questions clients were asking after the Presidential election; one of which was “How will the stock market perform in 2017?”
 
At the time I wrote that, if corporate and individual tax reform occurred, the stock market may rise an additional 10% (2,200 up to 2,400), which is about where the S&P 500 currently trades. Most of the rise would be due to the price-to-earnings multiple expanding in anticipation of lower taxes.
 
So, where do we go from here?
 
Looking back over the last 12 months, economic growth has accelerated, and labor wage inflation is starting to pick up. Labor wage inflation is being seen in highly-skilled labor positions, such as commercial construction workers and welders. Fast-food restaurants are seeing increased employee turnover--a sign that companies are growing and are willing to offer higher pay to attract workers. 
 
An improved economy and signs of inflation create a backdrop for the need to raise interest rates.
 
However, unlike many previous recessions, our economy underwent a significant deleveraging process that many business owners still vividly remember. This has resulted in business owners investing the bare minimum and only enough to service growth.
 
Realizing the scars from the financial crisis run deep and that business owners are reluctant to invest are unusual circumstances for economic recoveries, the Federal Reserve is playing it slow on raising interest rates.
 
Nonetheless, interest rates will rise through 2018 until they reach about 2%. Rising interest rates will increase the cost of borrowing and dampen inflation.
 
It is different this time though as the Fed is considering whether the U.S. Treasury should sell bonds which were purchased by the Federal Reserve Bank under the Quantitative Easing (QE) umbrella or let the bonds mature.
 
The distinction between the sale and maturity of QE bonds is important and could result in the next stock market drop.
 
The benefit of selling QE bonds would be increased interest rate flexibility (or the ability to increase rates more slowly), while still draining liquidity from our monetary system. Since short-term interest rate differentials are one of the driving forces of currency changes, it may soften some of the impact of President Trump’s protectionist policies. 
 
On the other hand, the only actual experience the Fed has with reducing QE was in 2013 during the “Taper Tantrum,” which created a short-term drop in the stock market. Many Wall Street pundits believe this drop was due to poor communication from the Fed, but nonetheless it was a scary time to be invested.
 
As a result of the “Taper Tantrum,” economists worry that selling QE bonds could be even worse for the stock market. Economic research and statistical analyses that have been conducted show the base case scenario is neutral to economic growth.
 
Over the next several quarters, investors will likely learn more about President Trump and the trajectory of interest rates and QE. Considering the stock market is near an all-time high, rational investing is more essential.

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