The FOMC’s decision to increase the federal funds rate to the range of 1.00% to 1.25% in June was no surprise as labor markets strengthened further and inflation conditions (recently softer) remained close to the Fed’s long-term objective. The recent Monetary Policy Report released by the Federal Reserve stated that even with the rate increases from the first half of 2017, the stance of monetary policy remains accommodative. The report also reiterated the Fed’s expectations of additional improvements in labor market conditions and a sustained return to 2% inflation. The noteworthy announcement from the report was the text stating the FOMC intends to begin the balance sheet normalization program this year provided the economy evolves broadly as anticipated. The plan will gradually reduce the Federal Reserve’s securities holdings by decreasing the reinvestment of principal payments. This should help to slowly unwind the Fed’s balance sheet that sits at $4.5 trillion in treasuries and mortgage backed securities. Going forward, the FOMC emphasized that monetary policy is not on a preset course, and the actual path of the federal funds rate will be data dependent.
International economies showed improvement during the first half of 2017. Overall, Eurozone growth was higher than previously estimated due to stronger labor markets and expansionary fiscal policies. However, recent data in the United Kingdom cited weak consumer confidence and slow growth inservices, construction, and manufacturing. Threats to the European Union’s (EU) survival have diminished thanks in part to France’s presidential election. Voters rejected populist/anti-EU candidates in favor of a new president (Emmanuel Macron) who is focused on reviving their economy and improving EU relationships. The German federal election in September is an additional hurdle for Eurozone improvement, but a favorable (pro euro) outcome will add another chapter to the European recovery story. Japan was able to sustain their economic improvement with respectable growth numbers for the first quarter of 2017. Exports continued to drive growth as a recovering global economy and a weaker yen made goods more affordable abroad. Consumer and business spending remained weak, but evidence suggests that Japanese policies and stimulus packages appear to be having a positive economic impact. China’s growth rate (6.9%) increased slightly over the previous quarter. Growth has been fairly consistent due to strong government infrastructure spending and a real estate boom, but the broad consensus is that the Chinese economy will slow in the second half of 2017. Government officials are hopeful that tighter fiscal policy and reforms should help to gradually decelerate growth. Containing financial risk and avoiding a housing bubble will be a top priority for the second half of 2017 and beyond. Emerging market performance was better but remained country specific. The stronger global economy, higher demand for technology related goods, positive earnings, stable commodity prices, and a weaker dollar contributed to improvements in many areas.
Our outlook for the domestic economy is still optimistic. We expect low but positive growth for the remainder of the year. We anticipate inflation to remain close to the Fed’s two percent target rate, and the labor force to move closer to full employment. We expect additional improvement in manufacturing, the housing market, corporate profits, and consumer spending. Short-term fluctuations in oil prices could be more frequent due to global inventory and output levels, but we believe prices should stay around the $50/bbl range for an extended period. All indications point to one more rate hike for the Fed this year, and the official start of the balance sheet reduction process. Barring a setback in the economy or a change in policy, we anticipate both to happen this fall. Washington’s inability to make meaningful progress on a new health care plan, tax reform, and infrastructure spending is disheartening. We remain hopeful, but we do not expect any legislative changes until 2018.
The international outlook is brighter. Economic conditions are improving across Europe and Asia, and we expect international markets to outpace domestic markets during the second half of 2017. While we anticipate divergences in financial outcomes, we believe the recent improvement in fundamentals and attractive valuations should contribute to strong financial performances in developed and emerging markets.
We are mindful of the potential risks to the domestic and international economies. The fading Trump economic boom, political gridlock, tight monetary policies, restrictive trade policies, Eurozone elections, immigration, a strong dollar, oil prices, China’s growth, BREXIT negotiations, and escalating geopolitical tensions are challenges that could negatively impact economic prosperity around the world. As always, we remain watchful!
The success in international equities during 2017 provides us with the perfect opportunity to explain why we advocate the use of this asset class as part of a diversified portfolio. Here are the reasons why:
· International stocks are becoming a larger part of the investment universe. Half of the world’s investable assets are outside the U.S.
· A large number of industry leading companies are foreign based.
· International stocks provide exposure to faster growing economies.
· International investments can potentially reduce overall portfolio volatility.
· Investments in foreign markets provide greater diversification opportunities.
There are some added risks associated with international investing. Economic and political instability of the foreign country, currency risks, market liquidity risks, and the cost of international investing are the main issues potential investors have to consider. Over the long-term, adding international investments to a diversified portfolio of domestic stocks and bonds is a wise investment decision that can have substantial benefits.
As I have often stated, our investment philosophy remains based on the fundamentals. We believe it is time---not timing---that matters most. History shows the successful long-term investor is patient, weathers market swings, and adheres to a disciplined investment process that includes a diversified asset allocation strategy based upon a tolerance for risk and need for return.
In closing, I want to thank you for the opportunity of working with you and for your continued confidence and trust. Please contact me if you have any questions.
Have a safe and enjoyable summer!
With kindest personal regards, I am
Very truly yours,
WILLIAM HOWARD & CO. FINANCIAL ADVISORS, INC.