We had a tremendous start to 2017. The U.S. stock market was up. The European stock market was up. The emerging markets were up. The first half of this year was the best first-half-year performance by the stock market since 2009. Why is the market doing so well? I believe its behavior in 2009 can be explained by the fact that we had just come through the credit crisis. The market crashed and then rebounded. It wasn’t unusual to see such a great rise after a severe bear market. 2017 is different because there was no market crash beforehand. The economy isn’t great. Jobs numbers aren't bad, but wages haven’t risen. I think the market is rising based on continued optimism in the Trump agenda: the prospect of tax cuts, the prospect of deregulation, and the prospect of repatriation of trillions of dollars overseas (it’s anticipated that much of that money could come back into the U.S. and go straight into stock buybacks, which would tend to drive stock prices up).
But bonds, which typically go down when the Federal Reserve raises interest rates, are also going up. I think the bond market is essentially saying "Fine, Feds. You think the economy is strong enough to raise interest rates, but we don't believe you." Bond and stock market behavior is reflected in a yield curve, which is the difference between long-term and short-term rates (you can read more about the yield curve in this article). Basically, a good yield curve rises and a bad one falls. According to Bloomberg, a bad yield curve has preceded a recession every time over the last forty years. Right, now, the yield curve is almost flat. I think it’s reflecting the uncertainty of our current position: not a lot of great new economic data, the situation in North Korea, and the Brexit-fueled negotiations in Europe. I anticipate that these reasons will keep the market flat or maybe even drive it down over the next three months. But leading into the fourth quarter we should see the Trump agenda progress and once there is traction that area, I believe the market will respond favorably.
But I do think we need to pay attention to the yield curve’s signals. In addition,
Nobel Prize-winning economist Robert Schiller, who warned investors about the Y2K crash in his 2000 book Irrational Exuberance, recently noted that market valuations have only been at this high twice in history: once right before the Y2K crash, and once before the crash of 1929. Again, I don’t see the market crashing soon. But the market can change very quickly. If we hit our “sell” trigger, we won't hesitate to get out of the market. Right now, the market is up, but it’s not time to be complacent. It’s time to put a plan in place to protect what you've built.