To borrow a literary title to headline the investment climate of late, ‘Great Expectations’ definitely comes to mind.  Markets clearly anticipate higher consumer spending, higher confidence, lower taxes, a deregulation ‘surge’, accelerating growth, infrastructure spending … or at least most of these … to produce higher corporate profits to justify rising stock prices.

Particularly noteworthy are the timing and realities of the past six months.  Both 2017’s first quarter and 2016’s fourth quarter generated some strong investment results.  But look below:

                                        4Q16     1Q17                                                      4Q16     1Q17

US Value Stocks           +6.6%    +2.6%            US Growth Stocks        +3.3%    +8.2%

US SmallCap Stocks     +8.8%    +2.5%            International Stocks    -1.9%     +8.4%

U.S. value and smallcap stocks drove late 2016, but not in the first quarter as U.S. growth and foreign stocks led and U.S. equities rose 5.4% overall.  Throughout, interest sensitive holdings – reduced by ~25% last October – lagged.  As for economic growth and corporate profits, we now know that both fell significantly from Q3 to Q4.  Initial figures for Q1 will soon be out.

Rather than predicting what may or may not come to pass, it is more important to note how related – and at cross currents – many key measures are.  The more the economy grows, the stronger the labor market grows.  The lower unemployment gets, the more likely the Federal Reserve will raise interest rates again – a ‘brake’ on the economy.  The higher rates rise, the stronger the U.S. dollar becomes – which hampers U.S. exports and squeezes profits … which puts downward pressure on stock prices.  And then there’s the current political environment.

Against this backdrop, four things seem prudent: 1) Continuing a bit more defensive strategy; 2) Maintaining a slight emphasis on value stocks given the current economic crosswinds; 3) Paying more attention to Europe, with its lower interest rates and higher profit growth than in the U.S.; 4) Further reducing holdings likely to suffer from additional Fed rate hikes.

This last point leads to a portfolio change.  Litman Gregory Alternative Strategies (MASFX) is a defensive holding divided between corporate bonds and U.S. equities.  It served us well as interest rates fell.  With that no longer the case, it is appropriate to sell it and divide its assets across three existing areas: 40% Short-Term Bond (VSGDX), 25% Int’l Core index (SWISX) and 35% U.S. Large Value/Growth indexes (SWPPX).  Fund management fees will be lower, too.

With this change and your current portfolio, we believe you are well-positioned for the forces affecting the economy and markets.  We will let you know of further needs for change and thank you for the continuing opportunity to serve you as our client.  Have a wonderful Spring!