2017 2nd Quarter Letter
Equity markets moved higher during the second quarter of 2017 as investors continue to discount the improved growth trajectory of the US economy. Robert Bender and Associates has outperformed the broad market indices this year as investors remain focused on high-quality growth stocks. Despite concerns over the durability of the current expansion, stocks remain in favor due to rising corporate earnings and the potential for lower tax rates. While the need for broad liquidity and low interest rates remains the topic of fierce debate, business confidence has improved as regulatory headwinds begin to recede.
The economy began the year with an improved growth outlook as first quarter GDP growth of 1.4% topped earlier estimates of 0.7%. Economic indicators point to further acceleration in GDP in the second quarter, perhaps as high as 3%. For the full year, many economists now expect GDP growth of approximately 2.5%, and at least 3% in 2018. Corporate profit growth, improved capital allocation, and better employment data have all played a part in the enhanced outlook. Rising wages are also contributing to a pickup in consumer spending, with strength seen in discretionary spending. In addition, the US economy is feeling the net effect of better activity in Europe as the region is now growing at 1.4%, compared to recessionary conditions a year ago.
As the US economy enters its ninth year of expansion many investors have asked whether natural economic cycles might indicate a slowdown is imminent. While this is the third-longest expansion in US history, it is also among the weakest. Since 2009, US GDP has averaged 2.1% growth, the slowest since 1949. While most economic recoveries experience sharp upturns, the current expansion has been weighed down by excessive regulatory burdens and restrictions on capital. These restrictions have resulted in improved bank balance sheets but have also reduced monetary velocity. In the past few months, capital allocation has started to increase as businesses perceive the current administration as more business friendly. Aggregate growth in S&P 500 earnings is expected to rise 7% in 2017. This figure does not include changes in current tax policy.
Since small businesses are responsible for more than 80% of new jobs in the US, lower regulatory burdens could be a further boost to the economy. Compliance with government rules and laws are a greater encumbrance on small companies, and regulation hinders small business formation, growth, and job creation. Profits could receive an additional boost from a reduction in the tax rate on repatriated cash from overseas. This could particularly benefit health care and technology companies since they are among the largest holders of overseas cash. Historically, companies have used repatriated cash primarily on stock buybacks and dividend increases.
While the Fed has begun to tighten short-term interest rates, the market now seems comfortable higher interest rates will accompany a higher rate of GDP growth. Even though short-term rates are rising, they remain at extremely low levels, particularly this far into an economic recovery. As it contemplates further rate hikes for this year, the Fed will likely keep an eye on the value of the dollar vs. other currencies. A sharply higher dollar could make US products less competitive overseas. The level of liquidity in the banking system in the form of net-free reserves and the steady growth of M2 money stock should provide a solid foundation of liquidity for the economy for the next several quarters.
Based on earnings expectations for 2018 of $135.00, the S&P 500 market multiple is valued at approximately 18x earnings. Robert Bender & Associates’ PEG ratio, which measures the price-earnings ratio of a company relative to its growth rate, now stands at 1.27x for 2018. The number of new highs on the New York Stock Exchange reached 297 in recent weeks. Typically, the number of stocks reaching new highs approaches approximately 800 near market tops. We feel the overall market multiple could remain steady this year as earnings growth keeps pace with the stock market.