Calculated Risks
Despite an irregular beat from Washington, the stock market continues to roll along like Ol’ Man River. The river is narrowing and there are eddies but the current remains unchecked. Since the unexpected victory by Mr. Trump almost five months ago, confidence has surged among many investors that American businesses will get a lift from changes in the tax laws and from spending in neglected areas like renewal of the country’s crumbling infrastructure. These are not yet on the table but optimism prevails that something will happen.
Much stock market behavior depends on “animal spirits” (or the lack thereof), which Lord Keynes defined as “the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations.” Well, there you are: math seems thrown to the wind as businesses and investors feel moved to take positive actions.
To the extent that rising optimism lifts consumer confidence, it may help pull U.S. economic growth out of its persisting sluggish channel. In this environment, investors should remember Professor Schiller’s caution, “The proper role of the government, like the proper role of the advice-book parent, is to set the stage. The stage should give full rein to the creativity of capitalism. But it should also countervail the excesses that occur because of our animal spirits.”
With the quarter ending, we are entering another quarterly earnings season. Current estimates for Q1 2017 are for a growth rate of 9.1% on the S7P 500, which would be the highest rate since Q4 2011. That would be more encouraging if the stumbling energy sector were not forecast to be the largest contributor to earnings growth and with that due to currently recovering oil prices and easy comparison to the energy sector’s losses a year ago. With energy kicked out, the estimated growth rate drops to 5.2%.
As the first quarter of 2017 closes, the S&P 500 is ahead 5.7% this year, which suggests that stock investors have faith in these estimates. This reflects optimism in U.S. economic growth, despite it having been in a low gear of only 2.1% annually since the Great Recession ended eight years ago. That pace actually slid to 1.9% last year, indicating the premium investors are placing on prospects of the new Administration upshifting the economy into a higher gear. Certainly, they are backing their beliefs with the stock market trading near recent record highs and margin debt at record levels.
My February 24 column suggested allocating as much as 15% of stock portfolios to short-term bond funds. I have also recommended increasing emphasis on stocks in the most successful large growth companies. Last week’s column featured two favorites, Apple (AAPL-$143) and Amazon (AMZN-$875), which have both since moved on to record highs.
Market leadership is confusing as certain sectors like transportation usually lead in strong markets and defensive issues like utilities in shaky times. Presently, technology is strong, as usual, but financials and transportation have softened and defensive issues like utilities and consumer stocks are strengthening. Even Coca-Cola, whose stock price seems supported by nostalgia as its earnings sag, is moving up.
Medical and biotech stocks can find or lose favor as growth stocks or as defensive holdings. With the government so involved in health care funding and drug prices, advanced research companies like Amgen (AMGN-$164) and Celgene (CELG-$123) that can punctuate expectations are preferable to the old stalwarts like Pfizer that are riding on hopes of merger proposals.
Stocks seem vulnerable to a “correction.” These can be abrupt but I believe the most likely outcome will be more drawn out as stocks adjust over the next few months to overshooting expectations of political boosts to earnings. “Calculated risk,” a traditional Navy doctrine that worked well at Midway, seeks weighing anticipated gains against associated possible losses. I am honing stock portfolios to core positions of larger companies with well-reasoned prospects of growth. Short-term bond funds are useful anchors to windward.
Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622
