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Quarter 1, 2017

The stock market continued to power ahead in the first quarter, marking the best quarterly start to a new year since 2013. The S&P 500 index gained approximately 5%, with the technology heavy NASDAQ performing above this level and the small-cap. Russell 2000 index trailing behind.  It is fair to say that a large portion of the market’s advance is directly attributable to rising confidence amongst corporate managers, and in particular small business owners.  The National Federation of Small Business Owners reported last month that its quarterly Optimism Survey soared a whopping fifteen percent from the same figure reported in the fourth quarter of 2016.  The sudden vaulting of this survey signals a clear thumbs-up by small business owners to the proposed agenda of the new administration in Washington.  Over the past year the three biggest concerns of small business owners has been 1) taxes, 2) regulation, 3) rising health-care costs.

Consumer confidence is also on the rise. The Conference Board recently released its March data which showed a significant jump of over 10 points to 125.6, marking its highest level in sixteen years.  A key takeaway from this report is that individuals now share a collectively stronger outlook for jobs and wages.  Consumer psychology is vital to the economy as better employment prospects lead to higher personal spending.  On the subject of hiring, the U.S. economy added 235,000 new jobs in February which was on top of 238,000 new additions the month before.  Just as important is the fact that wages are on the rise, up 2.8% on a year over year basis.

While the market has enjoyed a nice run over the past several months we know all too well that stocks can be extremely volatile in the short term. One bad headline or economic statistic can quickly send the market averages into a temporary tailspin.  Rather than get caught up in the daily news cycle it is far better to focus on long-term fundamentals.  Since companies report earnings only four times a year, these quarterly report cards help smooth out much of the daily headline noise and provide a better picture of the economy.  Corporate profits collectively rose 9.3% on a year over year basis in the final quarter of 2016.  After experiencing some weakness in 2015 and early 2016 corporate profits have now risen for two consecutive quarters and are likely to rise at least this much in the first half of 2017.  Consumer spending is being bolstered by lower energy prices and rising wages.  Capital spending is also beginning to show signs of new life as business confidence improves.

Given the recent market advance one might speculate as to whether there is still any potential buying power remaining. This question can best be answered by analyzing money flows. The Investment Company Institute (a trade organization which tracks global money flows) reports that there is still way more cash being directed into bonds in comparison to stocks.  For the first three months of 2017 ICI finds that money flows into bonds is still over twice the amount going into stocks.  While this doesn’t seem to make intuitive sense (especially since the Fed has stated its intention to raise interest rates over the balance of the year) it provides credence to the argument that there is still plenty of potential buying power remaining if investors begin to shift assets from bonds into stocks.  Major asset allocation changes don’t occur overnight, and in fact it may take large institutional investors many months to re-allocate huge pools of investment assets once the decision is made.