There are encouraging signs for the US economy’s current and expected performance. Falling unemployment and rising wages are boosting consumer spending. Corporate profits ramped up +9.3% year-over-year recently after five consecutive quarters of negative year-over-year profit growth. Management teams are increasing spending levels and engaging in equity friendly practices such as dividend increases, share repurchases, and merger activities. Meanwhile, inflation remains subdued. This fit nicely with the Federal Reserve’s desire to gradually “normalize” short term interest rates from 0.75% currently towards 2%. Indeed, the Federal Reserve was confident enough to raise interest rates 0.25% at its March 15th meeting judging that the economy was healthy enough to support higher rates. Most analysts now expect the Federal Reserve to hike interest rates an additional two times this year depending on a continued pick-up in US economic activity.
Bond yields have also risen significantly in recent months. The 10-year US treasury yield touched as high as 2.6% in March before retreating to a current 2.3%. As bond yields have risen, bank stocks have surged. Higher interest rates tend to boost the profitability of banks’ lending activities. As yields rise, bond prices fall, which is not a favorable relationship for bond investors. No one should be surprised that very low short term interest rates mean that money market funds offer meager returns.
US equity prices are probably fairly valued. As tailwinds from Federal Reserve monetary policy fade, equity markets should begin focusing more on company fundamentals such as earnings quality and specific valuation metrics. In such an environment, stocks of financially strong and steadily growing companies gain market favor. Our value-oriented investment philosophy and methodology have you well positioned for this shift with well-diversified portfolios of companies whose shares are reasonably to modestly valued.
