Defying the Skeptics

“Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.”

             – John Adams

The latest facts on the U.S. economy have been favorable and encouraging.

• The Bureau of Labor Statistics reported continuing employment growth in March, putting average monthly job gains for the first quarter at 209,000. This was an improvement from the 190,000 monthly pace for the opening quarter of 2015. The unemployment rate registered at 5% with welcome improvement in labor force participation.
• Average hourly earnings rose in March, bringing the year-over-year increase to 2.3%, indicating real progress in worker’s compensation.
• The Institute for Supply Management (ISM) reported that its March index of manufacturing activity rebounded to levels that augur continued economic expansion.
• The ISM Services Index for March posted its highest reading since December, increasing to levels portending ongoing economic growth.
• Further improvement was registered in the Index of Leading Economic Indicators, suggesting growth is likely to continue throughout the next year.

These and other facts have been a welcome counterpoint to all the negativity earlier this year. We are gratified that recent Bartlett commentaries anticipated this economic resilience, offering reassurance when financial markets experienced chaotic selloffs amid recession fears in February and similar anxieties last August.

Central Banks in Overdrive

The U.S. economy has expanded at a slow 2.2% annual rate since recovery started in 2009, far below the growth experienced during recoveries in the 1980s and 1990s. But America is galloping compared to developed economies in Europe and Asia. Stubbornly anemic performance in these regions has prompted another aggressive monetary policy response. The European Central Bank (ECB) and its counterpart in Japan have implemented negative short-term interest rates. The idea is that negative rates will prompt banks to make loans rather than holding excess reserves, thus stimulating more investment and spending, thereby fortifying economic growth. This unorthodox monetary strategy has been ineffective thus far, and has created new uncertainty about the health of financial systems. Designed to stimulate lending, negative rates might actually lower credit availability by reducing bank’s profitability.

We think central bankers should be very careful about further monetary stimulus. New initiatives may have unintended consequences. What is urgently needed is help from better fiscal and regulatory policies. Structural changes in taxation, entitlement spending, and infrastructure investment should all be on the to-do list. Higher tariffs and trade barriers – a recent staple of U.S. political discourse – are counterproductive and should be rejected. We recognize that this all seems unlikely with political polarization accentuated in an election year, so we hope for progress in 2017 and beyond.

The expectations summarized in our January commentary remain intact in April, supported by evaluation of additional data during the first quarter. As always, we endeavor to be dispassionate and objective, with assessments grounded in realism rather than optimism or pessimism.

• Moderate economic growth is likely. While the pace may be disappointing, we are mindful that an economy growing at 2% to 2.5% does not build the excesses – such as inflation and overproduction – that often precede recessions.
• Corporate profit growth was weak in 2015, pressured by factors including lower energy prices and a stronger U.S. dollar, the latter reducing exports and lowering the earnings from foreign subsidiaries. Weakness is likely to continue in 2016, with improvement possible in the second half of the year.
• Intermediate and long-term interest rates are likely to remain low, notwithstanding the possibility of a few increases in the Fed’s short-term policy rate. The key factors here are very low interest rates in Europe and Japan, and low inflation throughout the world.
• Equity valuations are not “cheap” but seem reasonable given low interest rates and low inflation. The S&P 500 Index is valued at approximately 16x projected earnings for 2016 based on the latest data from sources such as Bloomberg, Factset, and Morningstar. Moreover, many stocks provide dividend yields that exceed the yields offered by high-quality bonds, along with potential for dividend increases.

Though equity markets were barely positive for the first quarter, we still believe 4-8% returns are a reasonable expectation for the year, amid higher volatility and occasional corrections. Bonds should be comparatively stable with returns of 2-4%, and cash yields will almost certainly remain below 1%. We think carefully selected alternative investments can provide returns between equity and bond performance, while supplementing portfolio diversification and thereby providing additional risk management benefits.

We are keenly aware of the significant behavioral penalties that can result when emotion influences investment decisions. Hazardous practices like “market timing” and “performance chasing” are especially seductive and dangerous when volatility is elevated amid significant uncertainty. Bartlett will continue to navigate with careful value-based strategies, endeavoring to assure that market turbulence does not disrupt clients’ financial plans. Timeless principles will guide us – setting realistic goals, focusing on the long-term, maintaining appropriate asset allocation, diversifying prudently, and rebalancing periodically.

Concluding Comments

Bartlett accomplished record new business and a 99% client retention rate in 2015. We are adding new accounts at a steady pace so far in 2016. Our success is made possible by the confidence and trust of loyal clients like you, and we are very grateful. We hope you will recommend Bartlett to family members, friends, and colleagues who may need our investment management and financial planning services.