Leonard Rickey Investment Advisors

Market Summary

The rally from the fourth quarter of last year continued into the start of the first quarter as investors continued to bet on the Trump administration’s policies to cut taxes, reduce regulation and increase infrastructure spending. U.S. stocks, as measured by the S&P 500 Index, were up over 6% and reached another new all-time high in the first quarter. Midway through the quarter, the S&P 500 pulled back after the failure to repeal and replace the Affordable Care Act (Obamacare). Investors’ doubts grew that the Republican majority in Congress could unite and enact other major policy changes.

Despite the political uncertainty, consumers and business around the globe seemed significantly more positive about the outlook than they were this time last year. In Europe, business surveys rose to their highest levels in over five years and consumer confidence recovered to pre-crisis highs[1]. This helped both international stocks and emerging market stocks outperform U.S. stocks last quarter. However, both still significantly trail U.S. stock returns over five and ten years. U.S. bonds traded in a tight range throughout the quarter and finished positive despite the Federal Reserve hiking short term interest rates by .25% to .75%. Here is a summary of returns for the major indexes[2]:

	US Large Stocks (S&P 500 TR)	US Small Stocks (Russell 2000 TR)	International (MSCI EAFE)	Emerging Markets (MSCI EM)	US Bonds (Barclays US Agg Bond TR)
1st Quarter 2017*	6.07%	2.47%	7.25%	11.45%	.82%
3yr annualized*	10.37%	7.22%	.5%	1.18%	2.68%
5yr annualized*	13.3%	12.35%	5.83%	.81%	2.34%
10yr annualized*	7.51%	7.12%	1.05%	2.72%	4.27%

*Through March 31, 2017. All returns are in U.S. dollars. Source: Morningstar

 

Current Market Trends

Stocks continued their uptrend in the first quarter, although signs of weakness started to appear as the “Trump rally” started to fade in March. Both non-U.S. developed and Emerging Market stocks outperformed U.S. stocks for the quarter, with Emerging Market stocks leading the way. The change in the relative performance of Emerging Markets versus U.S. stocks was notable as they have significantly trailed U.S. stocks for the past six years. Below is a chart that compares the S&P 500 (U.S. stocks) index to the MSCI Emerging Markets index[3]. When the line goes up (from 2004-2011) it means Emerging Market outperformed U.S. stocks, when the line goes down (2011-2016) it means U.S. stocks outperformed. While the trend certainly hasn’t turned completely, the relative performance bottomed in early 2016 and again late last year.

 

Another notable trend during the quarter was the low stock market volatility. At one point during the quarter there was more than 100 days without a single one percent down day.  This was the longest such streak since 1995[4].

Finally, many of the so-called “Trump trades” that were hit hardest in the fourth quarter last year rallied in the first quarter as uncertainties grew over his policies. For example, emerging market stocks were down over 4% in the fourth quarter compared to up 11% this quarter; Mexican stocks were down over 9% last quarter compared to up 16% this quarter; U.S. Healthcare stocks were down over 4% in the fourth quarter compared to up over 8% this quarter; and Gold was down over 13% in the fourth quarter compared to up over 8% this quarter.[5]

Economic Update

While U.S. political issues dominated the headlines during the quarter, the economy continued to grow at a positive but slow pace. Economic data like inflation, unemployment, wage growth and manufacturing were generally strong during the quarter. The strong economic reports led to the Federal Reserve to raise short-term interest rates to .75%. This marked the third interest rate hike in the last 16 months (See chart below)[6]. The Fed indicated that they will raise rates slower than past cycle. Another two rate hikes were expected by investors for this year.

While the economic backdrop showed signs of improvement, the “soft” data derived from surveys of consumers and producers that indicate how they feel, was a lot stronger than “hard” data. “Hard” data, such as employment, durable goods orders, and housing starts numbers revealed the actual levels of economic activity. These were generally positive during the quarter but not as strong as “soft” data such as consumer sentiment readings, which were near multi-year highs (see chart below)[7].

One notable positive indicator in the “hard” data category was the Leading Economic Indicators Index (LEI), which made a new all-time high during the first quarter. This topped the previous peak from March 2006[8]. The LEI looks at 10 diverse economic indicators and has historically provided early warnings of recession.

The soft data includes the ISM Manufacturing Index and the Consumer Confidence Index, which both came in strong during the quarter. The ISM Manufacturing Index is obtained from a survey of manufacturing supply executives, and the Consumer Confidence Index is a survey that attempts to measure consumers’ assessment of current business and economic conditions. The Consumer Confidence Index finished near 15 year highs while the ISM Manufacturing Index was near it’s high of the past 7 years (See charts below). However, questions remained if these high readings will lead to higher economic growth or if expectations are too high.

Corporate Fundamentals

U.S. stock market valuations remained high during the quarter. Below is chart showing the Price to Sales (P/S) ratio of the S&P 500 over the last 60 years[9]. The P/S ratio is a popular metric that compares current prices to revenues. The higher the ratio the more an investor pays for the revenues of the S&P 500 companies. During the quarter, the P/S ratio was well above its historical average and near its all-time highs. When the P/S ratio is this high, future stock returns have historically been well below average (see yellow highlighted area).

Corporate balance sheets remained strong as many companies had a high cash balance as a percentage of their assets[10].

However, recently we’ve seen companies take on significantly more debt which may make them more vulnerable to rising interest rates. Debt isn’t necessarily a bad thing as long as interest rates remain low. However, if rates rise corporate interest expense will likely rise and cut into profit margins. In addition, a high debt balance may make it more difficult for a company to refinance and could increase the likelihood of bankruptcy.

Below are two charts showing the increasing debt on company’s balance sheets. The first one measures debt against Earnings[11] (EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization) and the second chart measures debt against U.S. Gross Domestic Product[12].

If you have any questions or would like more information on how this affects your accounts, please contact us.

 

IMPORTANT DISCLOSURES

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced herein is historical in nature and is not an indication of or a guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any particular strategy or investment will prove profitable.   As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. This newsletter should not be regarded as a complete analysis of the subjects discussed.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy.

The fast price swings in commodities and currencies can result in significant volatility in an investor’s holdings.

There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The

Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.

INDEX DEFINITIONS

The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It cannot be invested into directly.

The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices of approximately 800 stocks and is designed to measure equity market performance in 23 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, , Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.

The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index of approximately 900 stocks and is designed to measure equity market performance in 21 developed market countries outside of North America.

The Nasdaq Composite Index is the market capitalization-weighted index of approximately 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks, as well as limited partnership interests.

The MSCI Mexico Index is designed to measure the performance of the large and mid cap segments of the Mexican market. With 27 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Mexico.

The S&P GSCI Gold Index, a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark tracking the COMEX gold future. The index is designed to be tradable, readily accessible to market participants, and cost efficient to implement.

The S&P 500 Cons Discretionary Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® consumer discretionary sector. 

The S&P 500 Cons Staples Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® consumer staples sector. 

The S&P 500 Energy Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® energy sector. 

The S&P 500 Financials Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® financials sector. 

The S&P 500 Health Care Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® health care sector. 

The S&P 500 Industrials Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® industrials sector. 

The S&P 500 Materials Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® materials sector. 

The S&P 500 Telecom Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® telecommunication services sector. 

The S&P 500 Technology Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® information technology sector. 

The S&P 500 Utilities Index is a market cap weighted index comprised of those companies included in the S&P 500 that are classified as member of GICS® utilities sector. 

[1] JPMorgan Asset Management

[2] Morningstar

[3] StockCharts.com

[4] LPL Research

[5] Morningstar

[6] JPMorgan Asset Management

[7] Bloomberg, Morgan Stanley Research

[8] LPL Research

[9] Ned Davis Research

[10] JPMorgan Asset Management

[11] Thomson Reuters, Barclays Research

[12] JPMorgan Asset Management