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Quarter 2, 2017

Everyone managed to come home with a trophy during the first half of 2017 as both equities and bonds generated positive returns for the six month period. Stocks responded favorably to better than expected quarterly revenue and earnings reports from major corporations.  Bond investors remained encouraged by continued low levels of inflation within the U.S. economy.  Stock market volatility has been particularly low this year- with the largest market pullback not exceeding 2.8% during the first half of 2017.  This Goldilocks situation won’t last forever, but for the time being let’s just enjoy it.  For the June quarter the S&P 500 index generated a gain of 2.6%, with the six month return coming in at 8.2%.

The healthcare sector has been the best performing industry group so far this year, with a gain of nearly 16%. Technology stocks have come in a close second in terms of performance, appreciating 14%.  The healthcare industry is benefitting from favorable demographic trends while the technology sector is experiencing above average growth in niche areas such as cloud computing and cyber security.  The biggest losers so far this year have been energy and telecom stocks.  Energy stocks have taken it on the chin as the price of crude oil has fallen nearly 20% since the beginning of the year.  U.S. oil companies continue to expand their share of the global market as they take advantage of new technologies such as directional drilling and fracking.  Telecommunication stocks have suffered from increased price competition within their industry, which is good for consumers but not so great for telecom industry profits.

The Federal Reserve has made the decision to gradually tighten monetary policy in response to a stronger labor market. In fact the Fed has already raised short-term rates three times since December 2015, including two quarter-point rate hikes so far this year.  The bond market has been surprisingly sanguine despite the Fed’s more aggressive policy.  Long-term Treasury rates have actually declined by a quarter point from the beginning of the year.  Bond investors seem to be betting that inflation will remain a non-issue as labor costs remain in check and energy prices fall.  Still, one cannot ignore the inflation pressures occurring in healthcare and housing. Medical insurance premiums continue to escalate at double digit annual rates and housing prices are still expanding at a rate which is somewhere north of 5%.

For the time being there seems to be a fairly large disconnect between the monthly economic data being reported by the government and quarterly financial reports being issued by major corporations. First quarter GDP was reported to be a very anemic 1.4%. Yet companies within the S&P 500  reported accelerating revenue and earnings growth in the first quarter (corporate earnings were up by double digits in the first period).  Our bet is that the government is currently under-reporting economic activity and will eventually need to make some upward revisions to their data. We expect to see stronger GDP growth figures in both the second and third quarters- which should come as welcome news to most investors.