Investment Insights: Animal spirits flying too high?

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Oh snap! Snap, Inc., parent company of Snapchat, had the second largest U.S. tech initial public offering ever last week and debuted at a valuation of almost $30 billion. The IPO occurred on the back of another large event last week, President Trump’s speech to Congress.

Upward view of statue depicting an eagle with wings outstretched, with a little bit of the Federal Reserve building (Atlanta) behind itU.S. markets jumped after the presidential comments, with the S&P 500 Index gaining 1.39% the following trading day. While the tone of the address seemed to be more optimistic, Trump spoke only at a high level on a repeal of Obamacare, military spending, tax cuts, and infrastructure planning – his words did not include the level of detail that many investors and lawmakers were looking for. However, Congress appears willing to fill in the blanks. Yesterday, Republican lawmakers unveiled the American Health Care Act, their health care bill that would repeal and replace the Affordable Care Act. The animal spirits that lifted the market to each new high may have hit their limits, as the S&P 500 Index has failed to advance the past few trading sessions and consumer confidence may be starting to lose momentum. The University of Michigan’s Consumer Sentiment Index reached its highest level since the turn of the century in January before sliding in February.

Increased consumption from consumers and more realistic financial market valuations are main focuses for many economists at present. The OECD, an intergovernmental economic organization, projects 3.3% global growth this year and 3.6% growth in 2018. However, the group has warned the sub-par growth in the global economy may not yet be strong enough to withstand shocks from tariffs, overextended financial markets, or currency volatility. Chief Economist for the organization, Catherine Mann, said in an interview with Bloomberg, “We have acceleration, but I’m concerned about this really soft foundation to the recovery.” An OECD report cites a strengthening U.S. dollar may become a headwind to domestic growth as well as countries abroad, particularly emerging markets.

Meanwhile, the Federal Reserve is gung-ho on raising rates, which is generally associated with a stronger U.S. dollar. Fed officials have been releasing a frenzy of statements indicating that a rate hike at their meeting next week is practically a certainty, and markets seem convinced. This morning’s fed funds implied probability shows a 100% chance of a rate increase at the Fed’s March meeting, according to Bloomberg. While the Fed is making a strong effort to clearly telegraph the policy tightening to the broader markets, investors are awaiting the Fed’s European counterparts at the ECB to make the same switch. However, the lack of a credible trend in inflation has compelled the ECB to maintain its expansionary policy with a continuation of quantitative easing purchases throughout 2017.

We tend to agree with our economics team that the Fed will very likely hike three times this year – with one of those crossed off the list next week. While the Fed’s eagerness to raise rates is mainly due to rising inflation and improving economic data, substantial risks remain for the economy and the markets. Political risk remains a crucial factor as investors await detailed plans for U.S. policy reform, while elections in key European countries may see swings between far-left and far-right political parties. Equity market valuations, the strengthening U.S. dollar, and next week’s Fed meeting should be top of mind.

Chart showing market returns as of 3/7/17

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