Time to Party Like it s 1999

Transcription

1 PUGET SOUND WEALTH MANAGEMENT At Morgan Stanley Time to Party Like it s 1999 Nicholas J. Paget, CFP, CPM Morgan Stanley Wealth Management fa.morganstanley.com/pswm Wealth Advisor 601 Union St. tel Senior Vice President Suite 2900 fax Family Wealth Director Seattle, WA toll free NMLS: facebook.com/pugetsoundwm Prince released the Funk album in 1982 along with the hit smash Eighteen years later, Prince couldn t have known the US economy would undergo the longest bull market of all time between 1990 and Over a span of 113 months the S&P 500 gained 417% i. Following up that stretch, the S&P is currently in its second longest bull market. Starting in March 2009, this one has lasted 102 months and the S&P 500 has climbed 354% ii. Also, it would also appear the rate of appreciation is accelerating. In the last 18 months, the Dow Jones Industrial Average has increased 5,000 points. In theory rising markets should be great, but after two major pullbacks in 2000 and 2008, not everyone is so sure. Historically investor sentiment associated with this stage of the market cycle has been much more exuberant. However, during the last six months, retail flows have been coming out of US equity ETFs and mutual funds to the tune of approximately $75 billion iii despite positive economic data. In other words, while the markets move higher, retail investors are taking money out of stocks. As markets continue to move higher, investors are looking for signs to understand the strength of this market and where to go from here. As always our goal is to provide perspective and opinion so I will help explore some of the important economic signals, some of which are flashing green, and why I think this market has further room to run.

2 Growing PUGET Economy SOUND WEALTH MANAGEMENT At Morgan Stanley This chart shows that the US economy has continued to grow nearly each year since the recovery began in 2009 and may in fact be accelerating. GDP growth is expected to come in at 2.4% in 2017 compared to 2.1% in 2016 (a growth rate between 2-3% is viewed as healthy) iv. Though pundits continue to point to the relatively weak rate of GDP growth since the recession compared to the post-world War II economy, which grew at 3% whereas since 2011 the economy has grown at only 2% v, in my opinion this may provide further runway for this bull market because of its low and slow trajectory. The Republicans, which have the White House and both houses of Congress, believe that comprehensive tax reform, including sharply reducing the corporate tax rate, will strongly boost the economy and are working diligently to move that forward. In my opinion the market has not fully priced in the impact of lower corporate rates because in an age when the political machine is so slow to get things done it is hard to believe something as significant as tax reform is possible. However in the case of the Republicans, lower taxes are something near and dear to most of the party so there is strong incentive to get it done. Not to mention if they do not pass some type of tax reform, they risk creating re-election difficulties in the future. Lowering the corporate tax rate automatically reduces one key cost companies pay thereby boosting earnings and leading to higher earnings per share, the very thing we need in order to support higher stock prices. There has recently been some discussion relating to stock performance and of high corporate tax payers vs. lower corporate tax payers, leading some to believe the rate companies pay is irrelevant to growth. To me this is a somewhat silly argument because growth companies that have little profit likely pay the least amount of tax whereas slow growing large multinational value companies pay

3 significant taxes. My feeling is if we lower the corporate tax rates, the economic tide will lift all boats just some more than others. In terms of how lower tax rates for individuals will boost growth, evidence of that claim is mixed but using the Reagan tax cuts as a guide economic growth did improve. I believe tax-reform does have the propensity to spark short-term growth if by nothing else releasing pro-growth animal spirts leading to further stock gains. However I am concerned that if animal spirits do not lead to actual growth, and markets have over anticipated growth, it could create reason for a significant pullback. Nonetheless, as evidenced by today s 3.0% GDP growth rate vi in Q3 despite hurricanes and other natural disasters, the economy should expand in 2017 compared to 2016, supporting the case for higher stock prices. Labor After hitting a high of over 10% in 2009, the US unemployment rate now sits at 4.2%, significantly lower than the long-term average of 6% and the lowest since February 2001 vii. Since the recession we have replaced all of the jobs lost, and wages have improved consistently, albeit at a slow rate. Many pundits point to the upper right corner chart above, Labor Participation Rate, as evidence of a relatively weak jobs market and that many people have all but given up looking for a job. Lower participation rates may in fact be a growing issue as judged by the increased number of Americans receiving government assistance (Fed Chairwoman Janet Yellen has pointed to the opioid epidemic as potentially another cause viii ) but with an aging population and the baby boomer generation entering retirement, this is a challenging statistic the US

4 economy will be confronting for the foreseeable future. Another important statistic to look at when understanding the strength of the labor market is Job Openings and Labor Turn-Over or JOLT, a survey of about 16,000 businesses regarding total jobs, new hires, separations, and job openings ix. What JOLT shows is the number of people who leave their jobs voluntarily (e.g. quit) vs. involuntarily (e.g. get fired or laidoff) and it is a strong indicator of labor market strength because theoretically when more people are quitting their jobs there is presumably better opportunity elsewhere, supporting the case for a strong labor market. The ratio of Quits has not reached this height since early Profits

5 Q was the first quarter in a year and a half when profits grew quarter over quarter. Greatly driven by energy, the US economy actually experienced an earnings recession in 2015 and the first half of 2016 where each quarter profits shrank. Since that time however, profits have continued to expand. For the first half of the year in 2017, earnings grew at a double digit pace up 16.02% and 10.8%, respectively. And with Q (July September) earnings reporting now, with 17% of the companies having reported, 76% have reported positive earnings per share growth x. One comment that continually comes up is the stock market appears expensive. Relative to the long-term average both on a past and forward looking basis, stocks do appear expensive. However, when you compare the S&P 500 trailing earnings vs. the yield on the ten-year Treasury note, you find stocks look relatively cheap. Put differently, when you consider the low rate the ten-year Treasury is paying, stocks look relatively attractive compared to just about any anytime since the 70 s. Add to the equation the possibility of lower corporate tax rates and higher rates of economic growth, and the earnings picture could continue to improve for at least the next few quarters.

6 Interest Rates For what seems to be a very long time, interest rates have been falling or stayed low leading many investors to believe that we are in a new age of low rates. However, as the chart shows above interest rates are potentially less a function of what the Federal Reserve says or does, and more a function of economic growth. If in fact we do get further growth because of tax reform or from a number of other pro-growth initiatives, interest rates may follow suit putting further pressure on stocks. Until that happens however rates will likely be in a range accommodative to further growth relative to long-term averages, which will continue to make historically expensive stocks appear fairly-valued. Quick word on inflation: At this point it appears inflation expectations are low but according to Morgan Stanley they could be picking up xi. The Federal Reserve by mandate must moderate long-term interest rates and stabilize prices. In my opinion, if we create further growth through tax-reform and other pro-growth measurements we will create further inflation, specifically as a result of wage growth in an already tight labor market. Higher inflation means the Fed will likely raise rates to stabilize prices, which could be a drag on future growth. However, it will be some time before we see these policies put into effect and how they impact growth.

7 Moving Forward Where do we go from here? In my opinion we are in the later stages of this bull market, call it the seventh inning stretch, and until we see a deterioration of growth or profits due to changing economic tides, higher rates, or overinflated expectations, markets can move higher. I do think as we move into 2018 the ability for companies to grow their profits year over year compared to a particularly strong 2017 will be challenged, but if we do get tax reform that lowers the corporate tax rate and repatriates foreign held dollars, then the rally potentially ensues longer. We do not put much time into worrying about global exogenous shocks like North Korea or Iran because they are simply impossible to predict. Natural disasters similarly are difficult to predict and have negative impacts to the economy but the rebuilding efforts are generally strong enough to offset. On our team we stay consistent with the belief that the most important decisions about investments are not made while the seas are rough but before the ship has even set sail. Even if we have a strong idea that the next recession will hit, it doesn t necessarily mean we will advise clients to hide under a rock by selling stocks. Rather, if we have set up proper allocation to meet short, medium, and long-term goals; own high-quality companies; rebalanced and tactically reallocated when appropriate; controlled investment cost; and helped our clients navigate their emotions to avoid making key mistakes, then history would suggest long-term results should align with goals. And while we understand these tools and best practices won t necessarily make clients feel better the next time a recession hits, this approach will better prepare them to take advantage of the superior long-term growth rate of stocks relative to bonds and cash, and make better decisions when it is crucial to do so. In summary, the scene is set, the party has been going on for a while, and everyone is having a good time. The mood is festive: houses and portfolios have increased in value, the economy is growing, most people have jobs, and despite all the noise, a number of people aren t quite ready to step on the dance floor. My suspicion is the music will continue to grow louder to the point when it will be hard to ignore, and just as the last person succumbs to the fun, the record will skip and the party will end. Until that point, might as well party like its Nicholas J. Paget, CFP, CPM Senior Vice President, Family Wealth Director Wealth Advisor Puget Sound Wealth Management at Morgan Stanley CRC # Date of first use: 10/31/2017

8 PUGET SOUND WEALTH MANAGEMENT At Morgan Stanley i Wieczner, Jen. Happy Birthday, Bull Market! You May Not Live To See Another One. Fortune, 9 Mar. 2017, fortune.com/2017/03/09/stock-marketbull-market-longest/. ii Goldberg, Steven. 5 Reasons Stocks Should Keep Climbing Oct. 2017, S001-5-reasons-stocks-should-keep-climbing.html. iii Wilson, Michael, and Morgan Stanley Global Investment Committee. Finally Seeing Some Optimism. Positioning, 19 Oct. 2017, pp iv Amadeo, Kimberly. What Will the Economy Do in 2017 and Beyond? The Balance, 20 Sept. 2017, v Mathews, Chris. GDP Growth: U.S. Economy Post-Recession Is Worse Than We Thought. Fortune, 30 Jan. 2015, fortune.com/2015/07/30/us-gdpeconomy/. vi CNBC. US Economy Grows 3 Percent in the Third Quarter on Inventories, Trade. CNBC, CNBC, 27 Oct. 2017, vii Ferreira, Joana. United States Unemployment Rate Data Chart Calendar. United States Unemployment Rate Data Chart Calendar, Trading Economics, 6 Oct. 2017, tradingeconomics.com/united-states/unemployment-rate viii ix Bureau of Labor Statistics Data. U.S. Bureau of Labor Statistics, U.S. Bureau of Labor Statistics, 27 Oct. 2017, data.bls.gov/timeseries/ JTS QUR. x Butters, John. Earnings Insight. FactSet, 20 Oct xi Team, Morgan Stanley. Morgan StanleyVoice: What's Weighing On Inflation? Forbes, Forbes Magazine, 10 Oct. 2017, morganstanley/2017/10/10/whats-weighing-on-inflation/#36111ef2af86. The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Wealth Management or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results. S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index. Dow Jones Industrial Average is a price-weighted index of the 30 blue-chip stocks and serves as a measure of the U.S. market, covering such diverse industries as financial services, technology, retail, entertainment and consumer goods. An investment cannot be made directly in a market index. This material is intended only for clients and prospective clients of the Portfolio Management program. It has been prepared solely for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument, or to participate in any trading strategy. The individuals mentioned as the Portfolio Management Team are Financial Advisors with Morgan Stanley participating in the Morgan Stanley Portfolio Management program. The Portfolio Management program is an investment advisory program in which the client s Financial Advisor invests the client s assets on a discretionary basis in a range of securities. The Portfolio Management program is described in the applicable Morgan Stanley ADV Part 2, available at or from your Financial Advisor. Morgan Stanley Smith Barney LLC. Member SIPC.