Commentary by Clark Wagner, President, Foresters Investment Management Company, Inc. and Chief Investment Officer, Foresters Financial
The first half of 2017 was generally positive for the U.S. economy and financial markets. Unemployment dropped to a 10-year low in May, the stock market continued its eight year bull run supported by strong earnings, and the U.S. bond market remained attractive relative to other developed countries.
Looking forward there are three themes we’ve identified of which investors should be aware.
The first is the Fed’s move to a more normalized monetary policy by slowly raising rates. Second, in most cycles increased inflation goes hand-in-hand with an uptick in employment and rising rates, but so far this year inflation indicators have not been moving higher. The third theme, which has helped to keep interest rates down, is the buying of U.S. bonds by overseas investors, attracted by relatively high U.S. yields. All three of those themes will have an impact on how the second half of the year plays out for investors, as we will discuss below.
U.S. is the world’s bond market of choice
One of the biggest risks to the U.S. bond market is that when foreign central banks finally begin to raise rates, investors will move back to their home markets to eliminate foreign exchange risk. That capital shift could well be the catalyst for higher interest rates. For now, though, the U.S. bond market remains the market of choice for global investors. Among U.S. fixed income sectors, the municipal bond market in particular looks well supported. Munis had a big sell-off at the end of the year due to worries about tax reform, but in the absence of any concrete tax proposals and following Treasury Secretary Mnuchin's favorable attitude toward retaining municipal bonds’ tax exemption, buyers have come back. Year-to-date, the muni market is up about 3.8%. When all the tax benefits are computed, the sector is dramatically outperforming the other high grade markets. And this summer we expect demand to significantly outstrip supply in the municipal sector.
Stocks should continue adding returns
Looking forward, we feel the economic environment is still supportive of stocks, although another jump of 10% this year would be surprising. We continue to expect interest rates to rise gradually, although the effect will be muted due to the lack of inflation and continued foreign bond buying, and so should not affect stocks. Indications on corporate earnings and overall economic growth continue to look positive.
In terms of risk, if foreign investors pull money out of the U.S. bonds, as mentioned earlier, it will ripple into the stock markets as valuations become less attractive.
Investors should also pay attention in the coming months to volatility. It has been relatively low for so long, that many observers feel that some kind of a correction is inevitable before the end of the year.
While it’s always important to exercise caution, we continue to believe that on the whole, investors are still better off in the market rather than sitting on the sidelines.