Investment Strategy Outlook May 10, 2017

Transcription

1 Baird Market & Investment Strategy Investment Strategy Outlook May 10, 2017 Please refer to Appendix Important Disclosures. Fed Looking Past First-Quarter Disappointments Outlook Summary Highlights: Surge In Investment Spending Could Signal Secular Shift Earnings Rebound Not Yet Relieving Valuation Pressures Sentiment Balanced Despite Rising Optimism Seasonal Patterns Becoming More Challenging Weight of the Evidence Remains Bullish Stocks Lacking Momentum, Continuing Sideways Drift Opportunities For Diversification Emerge With Asset Correlations Falling As we move through the second quarter, global policy uncertainty appears to be easing somewhat and new highs are being made around the world. Fed On Pace To Raise Rates In June As the news focus turns from French elections to Italian elections, we are reminded that there will always be another potentially upsetting headline Sector Leadership Remains Cyclical: event coming over the horizon. At home, there is tension between the data Technology, Industrials, Discretionary showing that economic growth slowed in the first quarter (the initial report Showing Strength for first-quarter GDP showed growth of just 0.7%, the slowest pace in three years) and corporate earnings reports that are showing a continued rebound on both the top and bottom line. In this environment, we turn our focus to the Federal Reserve and its projected path of policy normalization (i.e., interest rate hikes) for With one rate hike already in the books this year and another two being seen as likely, Fed policy may turn into a headwind for stocks later this year. But for now it remains neutral and the willingness of the Fed to look past disappointing economic data in the first quarter speaks to an underlying confidence in the still-bullish economic Indicator Review fundamentals. Fundamental Factors (What Could Happen) Federal Reserve Policy Neutral 0 Economic Fundamentals Bullish +1 Valuations Bearish -1 Technical Factors (What Is Happening) Investor Sentiment Neutral 0 Seasonal Patterns/Trends Neutral 0 Tape (Breadth) Bullish +1 Weight of the Evidence = Bullish +1 From our perspective, the overall weight of the evidence remains bullish and the path of least resistance for stocks over the intermediate term is higher. Beneath the surface, we have moved sentiment from bearish to neutral and we have dropped seasonal patterns and trends from bullish to neutral. Valuations remain bearish and breadth remains bullish. As we have suggested previously, declining correlations across asset classes could mean renewed benefits from diversification for asset allocators, and opportunities in leadership rotation for tactical investors. Bruce Bittles Chief Investment Strategist bbittles@rwbaird.com William Delwiche, CMT, CFA Investment Strategist wdelwiche@rwbaird.com R.17

2 Federal Reserve Policy is still neutral. While the Fed has raised rates three times (by a total of 75 basis points) since late 2015, an uptick in inflation during that time period means that real rates (interest rates less inflation) have actually been declining. Both long-term and shortterm real rates remain below their longterm averages, suggesting that it would be premature at this point to suggest that the Fed has become unfriendly. If inflation continues to trend higher, the Fed may feel compelled to accelerate the pace of tightening just to avoid falling behind the curve. While this is not expected by the market currently, the Fed has demonstrated its ability to get market expectations in line with its plans in relatively short order. Signaling from the Fed could get a bit more complicated in the second half of 2017 as the focus expands to include not just interest rate hikes (another 25 basis points of tightening at the June fed meeting is already anticipated) but also the potential unwinding of the Fed s balance sheet. This was expanded dramatically during the financial crisis and has been maintained at an elevated level since. Fed officials have begun talking about reducing the size of the balance sheet sooner rather than later, and at this point beginning of a gradual unwind in late 2017 seems likely. If this is accompanied by additional rate hikes, it may signal that Fed policy has shifted to become a headwind for stocks. We will be watching the yearly change in T-Bill yields for evidence of this shift. Robert W. Baird & Co. Page 2 of 8

3 Economic Fundamentals remain bullish. There are two ways of looking at the health of the economy. One can evaluate growth relative to recent and historical trends and one can evaluate the incoming data relative to expectations. After a period of persistent underperformance relative to expectations, the U.S. economy fared much better than expected in the second half of 2016 and into 2017 (seen graphically by the surge in the economic surprise index for the U.S.). As disappointing data for the first quarter has been reported, the economic surprise index has moved back into negative territory. The history of these economic surprise indexes, however, suggests this should not be too surprising. Expectations surged in late 2016 and while not all the data has been disappointing, the economic headlines have been. This actually provides a chance for a re-set of expectations. Furthermore, while data in the U.S. has not lived up to expectations, the rebound in growth being seen in Europe continues to surprise to the upside. From a global perspective, the economy continues to fare better than expected. Not all the data in the U.S. has been discouraging. Headline GDP data for the first quarter showed the weakest growth in three years, but real nonresidential fixed investment spending surged nearly 10% in the quarter, the best showing since This suggests that the surge in business confidence seen at the end of 2016 is being followed with increased capital spending. A continued upswing in investment spending is critical if we are going to see productivity growth rebound. The weak headline GDP data are also at odds with strong labor market data showing still-robust hiring trends and widespread job openings. Robert W. Baird & Co. Page 3 of 8

4 Better trends in the underlying data and still-strong growth overseas are also reflected in corporate earnings reports. Both revenue growth (8%) and earnings growth (13%) for the S&P 500 in the first quarter are showing their best gains since While some degree of this corporate recovery is based on favorable year-ago comparisons, it is worth noting that nearly 80% of the companies in the S&P 500 that have reported first-quarter earnings have come in with positive earnings surprises, the best since So far, upside to earnings in the first quarter has come at the expense of expectations for the remainder of the year. If full-year earnings expectations can start to drift higher, it could be strong evidence that a sustainable shift towards better growth has occurred. Source: Financial Times Even with the improving earnings backdrop, Valuations remain bearish. Given the divergence between price and fundamentals that has occurred in recent years, it will take more than one or two quarters of strong earnings growth to relieve valuations pressures. It is encouraging, however, that the recovery in earnings is being driven by better top-line results. Importantly, valuations speak to risk and elevated valuations suggest an elevated risk environment (an important point given that many measures of volatility suggest placidity bordering on moribundity). In other words, even as corporate results are improving and stock market volatility has declined, risks remain elevated. Robert W. Baird & Co. Page 4 of 8

5 Sentiment is now neutral. We have been watching the sentiment surveys for evidence that excessive optimism has been unwound. After relatively modest pullbacks among Advisory Services Bulls (which dropped from 62.7% to 49.5%) and the NAAIM exposure index (which declined from to 67.5), optimism has rebounded in recent weeks. Individual investors saw a more complete unwinding in optimism, with bulls dropping form a post-election peak of 49.9% to a recent low of 25.7%, but here too optimism is again rising. A more complete unwinding of optimism (and perhaps more importantly, a sustained uptick in pessimism) could have helped clear the way for a meaningful upside move for stocks. History suggests stocks market gains can be hard fought when the crowd is lined up in the bullish camp. In contrast to the sentiment surveys, fund flow data suggest investors have turned more skeptical on equities, particularly U.S. equities. After seeing net outflows for the first three quarters of 2016, equity funds experienced a surge in inflows in the fourth quarter of last year, with the fourweek total of inflows peaking at $30 billion in the first quarter of Since then flows have ebbed considerably as investors took a more cautious view on equities. U.S. equity funds have the largest outflows in more than a year and a money manager survey suggests exposure to U.S. stocks reached a nineyear low in April. The more cautious data from a fund flow/allocation perspective offsets the rising optimism in the surveys, suggesting sentiment overall is neutral. Robert W. Baird & Co. Page 5 of 8

6 Seasonal patterns and trends have been downgraded to neutral. Usually by the time a tendency becomes widely enough known to have its own cliché, the effects of the tendency become more muted. The Sell in May mantra gets lots of attention every year, but apparently deservedly so. There is little evidence that recent years have seen a diminishing in effectiveness of this seasonal switching strategy. Stocks have tended to see the bulk of their yearly gains between November and April, with the May to October time period posting relatively meager gains and rising less than 60% of the time. This year it comes with welladvertised composite cycle headwinds becoming pronounced in the second half of the year. Breadth remains bullish, but robustness of the rally is getting frayed around the edges. The good news is that even as the S&P 500 has drifted largely sideways for the past two months, the percentage of industry groups in up-trends has remained relatively strong at 65%. From a more cautious perspective, the number of individual stocks (and sectors) making new highs has been muted even as the indexes have made at least marginally higher highs. While not yet rising to the level of a red flag, the lack of new highs suggests the S&P 500 may not yet be set to break out to the upside. An expansion in the number of stocks making new highs would argue that the cyclical rally is set to resume, while further deterioration in the percentage of industry groups in up-trends would suggest further consolidation at the index level is needed. Source: StockCharts Robert W. Baird & Co. Page 6 of 8

7 BAIRD STRATEGIC ASSET ALLOCATION MODEL PORTFOLIOS Baird offers six strategic asset allocation model portfolios for consideration (see table below), four of which have a mix of equity and fixed income. An individual s personal situation, preferences and objectives may suggest an allocation more suitable than those shown below. Please consult a Baird Financial Advisor in determining an asset allocation that will meet your needs. Model Portfolio Mix: Stocks / (Bonds + Cash) Risk Tolerance All Growth 100 / 0 Well above average Capital Growth 80 / 20 Above average Growth with Income Income with Growth Conservative Income Capital Preservation 60 / 40 Average 40 / 60 Below average 20 / 80 Well below average 0 / 100 Well below average Strategic Asset Allocation Model Summary Emphasis on providing aggressive growth of capital with high fluctuations in the annual returns and overall market value of the portfolio. Emphasis on providing growth of capital with moderately high fluctuations in the annual returns and overall market value of the portfolio. Emphasis on providing moderate growth of capital and some current income with moderate fluctuations in annual returns and overall market value of the portfolio. Emphasis on providing high current income and some growth of capital with moderate fluctuations in the annual returns and overall market value of the portfolio. Emphasis on providing high current income with relatively small fluctuations in the annual returns and overall market value of the portfolio. Emphasis on preserving capital while generating current income with relatively small fluctuations in the annual returns and overall market value of the portfolio. Baird s Investment Policy Committee offers a view of potential tactical allocations among equity, fixed income and cash, based upon a consideration of U.S. Federal Reserve policy, underlying U.S. economic fundamentals, investor sentiment, valuations, seasonal trends, and broad market trends. As conditions change, the Investment Policy Committee adjusts the weightings. The table below shows both the normal range and current recommended allocation to stocks, bonds and cash. Please consult a Baird Financial Advisor in determining if an adjustment to your strategic asset allocation is appropriate in your situation. Asset Class / Model Portfolio All Growth Capital Growth Growth with Income Income with Growth Conservative Income Capital Preservation Equities: Suggested allocation 95% 75% 55% 35% 15% 0% Normal range % 70-90% 50-70% 30-50% 10-30% 0% Fixed Income: Suggested allocation 0% 15% 35% 45% 50% 60% Normal range 0-0% 10-30% 30-50% 40-60% 45-65% 55 85% Cash: Suggested allocation 5% 10% 10% 20% 35% 40% Normal range 0-10% 0-20% 0-20% 10-30% 25-45% 15-45% ROBERT W. BAIRD S INVESTMENT POLICY COMMITTEE Bruce A. Bittles B. Craig Elder Jay E. Schwister, CFA Managing Director Director Managing Director Chief Investment Strategist PWM Fixed Income Analyst Baird Advisors, Sr. PM Kathy Blake Carey, CFA Jon A. Langenfeld, CFA Timothy M. Steffen, CPA, CFP Director Managing Director Director Associate Director of Asset Mgr Research Head of Global Equities Director of Financial Planning Patrick J. Cronin, CFA, CAIA Warren D. Pierson, CFA Laura K. Thurow, CFA Director Managing Director Managing Director Institutional Consulting Baird Advisors, Sr. PM Director of PWM Research, Prod & Svcs William A. Delwiche, CMT, CFA Managing Director Investment Strategist Robert W. Baird & Co. Page 7 of 8

8 Appendix Important Disclosures and Analyst Certification This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST The Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are unmanaged common stock indices used to measure and report performance of various sectors of the stock market; direct investment in indices is not available. Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United States Securities and Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and regulations may differ from Australian laws. This report has been prepared in accordance with the laws and regulations governing United States broker-dealers and not Australian laws. Copyright 2017 Robert W. Baird & Co. Incorporated Other Disclosures United Kingdom ( UK ) disclosure requirements for the purpose of distributing this research into the UK and other countries for which Robert W. Baird Limited ( RWBL ) holds a MiFID passport. This material is distributed in the UK and the European Economic Area ( EEA ) by RWBL, which has an office at Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB and is authorized and regulated by the Financial Conduct Authority ( FCA ). For the purposes of the FCA requirements, this investment research report is classified as investment research and is objective. The views contained in this report (i) do not necessarily correspond to, and may differ from, the views of Robert W. Baird Limited or any other entity within the Baird Group, in particular Robert W. Baird & Co. Incorporated, and (ii) may differ from the views of another individual of Robert W. Baird Limited. All substantially material sources of the information contained in this report are disclosed. All sources of information in this report are reliable, but where there is any doubt as to reliability of a particular source, this is clearly indicated. Robert W. Baird Group and or one of its affiliates may at any time have a long or short position in the company/companies mentioned in this report. Where the Group holds a long or short position exceeding 0.5% of the total issued share capital of the issuer, this will be disclosed separately by your RWBL representative upon request. This material is only directed at and is only made available to persons in the EEA who would satisfy the criteria of being "Professional" investors under MiFID and to persons in the UK falling within articles 19, 38, 47, and 49 of the Financial Services and Markets Act of 2000 (Financial Promotion) Order 2005 (all such persons being referred to as relevant persons ). Accordingly, this document is intended only for persons regarded as investment professionals (or equivalent) and is not to be distributed to or passed onto any other person (such as persons who would be classified as Retail clients under MiFID). Robert W. Baird & Co. Incorporated and RWBL have in place organizational and administrative arrangements for the disclosure and avoidance of conflicts of interest with respect to research recommendations. Robert W. Baird Group and or one of its affiliates may be party to an agreement with the issuer that is the subject of this report relating to the provision of services of investment firms. An outline of the general approach taken by Robert W. Baird Limited in relation to conflicts of interest is available from your RWBL representative upon request. Baird s policies and procedures are designed to identify and effectively manage conflicts of interest related to the preparation and content of research reports and to promote objective and reliable research that reflects the truly held opinions of research analysts. Analysts certify on a quarterly basis that such research reports accurately reflect their personal views. This material is not intended for persons in jurisdictions where the distribution or publication of this research report is not permitted under the applicable laws or regulations of such jurisdiction. Investment involves risk. The price of securities may fluctuate and past performance is not indicative of future results. Any recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. You are advised to exercise caution in relation to the research report. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. RWBL is exempt from the requirement to hold an Australian financial services license. RWBL is regulated by the FCA under UK laws, which may differ from Australian laws. As such, this document has not been prepared in accordance with Australian laws. Robert W. Baird & Co. Page 8 of 8