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Analyst Corner

As we entered 2017, the backdrop was one of tightening financial conditions and a good deal of optimism over fiscal, regulatory, corporate and individual tax reform. Long-term interest rates were moving higher and the Federal Reserve had just acted one more time by raising short-term interest rates by 0.25% while signaling 2 to 3 more hikes for the remainder of the year. The November Presidential election result created an interesting narrative around markets which seemingly further propelled investment gains. If one backs away from the overall noise of the election, a synchronized global reflation had already been well underway since the summer of 2016. This simply means that inflation, interest rates and growth were modestly moving higher in a noticeable uptrend across several key global markets all at once. U.S. equity markets and interest rates powered higher as part of this trend and the election provided an additional catalyst.

Upon reaching the end of Q1 2017, the Federal Reserve has once again elected to raise the short-term funding rate by 0.25% and now targets a full 1% which continues us down the tightening path against a backdrop of sustained and modest economic growth. With inflation running near 2%, however, the real (after inflation) funding rate is still in negative territory and has not yet normalized relative to earlier growth cycles. Despite the decision to raise the Federal Funds target rate, market participants actually read the committee’s posture as more dovish than hawkish due largely in part to leaving the forward guidance for future hikes unchanged. The optimism around regulatory reforms impacting energy, healthcare and financial sectors of the economy seems warranted given the new administration’s signals, but corporate and individual tax reform agendas may be moved right on the calendar into 2018 when things are all said and done. Confidence indicators and business optimism for the future broadly continue to provide a tailwind though it is notable that some of this optimism is fading in areas such as energy and banking as fundamental constraints and realities replace excessively rosy outlooks over the intermediate term.

Market symmetry is generally balanced until more forceful drivers emerge, while the longer term uptrend in equities is intact.

Positive Market Influences:

Synchronized Global Reflation -- An oil price rally, strong credit creation impulses and continued monetary policy support all combined to produce an observably higher trend in growth, interest rates and inflation. Whether or not this is a cyclical trend or if the higher levels represent a new paradigm of global growth and a secular trend, remain to be seen.
Consumer Confidence -- Both the University of Michigan’s Index of Consumer Sentiment and the Conference Board’s Confidence Index are at markedly higher levels relative to the last decade.
Small Business Optimism -- The National Federation of Small Business Optimism Index is at its highest level since 2004 and has seen rapid gains in recent months. As with consumer confidence, this type of soft survey data will need to be followed up with operating results over time in order to validate that the business climate is indeed warming.

Negative Market Influences:

Tightening Financial Conditions -- The taper of Quantitative Easing measures is concluded and short-term rates are very gradually being adjusted higher. Long-term rates are similarly moving higher indicating that firms will face higher borrowing costs over time, if the trend continues.
Fiscal and Tax Policy Delays -- Expectations for the pace of policy rollouts in regards to fiscal and tax policy have shifted to the right as difficulties reaching consensus on major features of legislation have emerged.
Valuation Concerns -- Many years of low interest rates have expanded valuation multiples and increased financial asset prices. Now that policymakers are attempting to move rates higher, we are closer to a point where higher interest rates could start negatively impacting the stock market.


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© The Odessa File 2016
Charles Haeffner
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Odessa, New York 14869

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