We held our 1Q-17 investment strategy meeting on December
21, 2016. It was an interesting and fairly momentous meeting given the recent
Presidential election. The outcome of the election adds an element of
uncertainty that makes forecasting a bit more difficult currently. While there
has been a lot of media coverage about what Trump’s strategies may be in areas
such as foreign and domestic policy, defense policy, taxation, healthcare, and
fiscal policy, it is still uncertain how all this will play out.
Based on what we have seen so far, it would appear that a
Trump administration could be reasonably pro-business. Trump himself comes from
the business sector and appears to be bringing into his cabinet a number of
people with high profile business backgrounds. If the new administration is
going to take more of a “pro-business” approach, on the surface it would appear
to have positive implications for the economy and hence, the stock market. But
again, at this point, “visibility” into the new administration and its policies
is limited.
As of now, there does appear to be better visibility for
some of the key factors that drive the stock market, the two most important
being valuation and corporate profits. After 4-5 quarters of declines, corporate
profits are now expected to grow 8-10% in 2017, which is a positive. Stock
valuation is not exceedingly high. We estimate the forward P/E on S&P500 is
now about 17x. This is above the long-term average of about 15x but not in a
range that would be a material impediment, in our opinion, and certainly not
excessive when compared to bond yields. The outlook for the U.S. economy
remains stable. We continue to expect more of the “2+2” economy: 2% GDP growth
and 2% inflation. And while we believe the Fed will raise rates again in 2017,
we expect it will remain cautious and deliberate in its moves, which should not
be overly disruptive to the stock market. These factors support a continued
constructive outlook for U.S. equities. China and its economy, in our view,
continues to be the greatest risk for global financial markets and is one
reason why we decided at our meeting to eliminate a position in emerging
markets.
With respect to changes in your portfolios following the
meeting, overall equity exposure was reduced very slightly, about 2%, while
fixed income exposure remained essentially unchanged. The slightly lower equity
exposure should help to buffer against what could be increased market
volatility in the new year. Within sectors, we slightly reduced our exposure to
mature equity and increased exposure to small cap stocks. We think smaller cap
stocks could stand to benefit more from the potential for lower business taxes
currently being discussed by the incoming administration. Within the
international sector, we eliminated exposure to emerging markets and added a position
in large-cap European stocks. The investment in European stocks is based
primarily on valuation which remains very attractive. We reduced our exposure
to REITs by about 8% as we believe returns in the sector could be more muted in
a rising interest rate environment. Within commodities/natural resources, we
eliminated positions in gold and energy and replaced these with the Flexshares
Global Upstream Natural Resources ETF (GUNR). We like this ETF because it has
nicely balanced exposure across five important areas: energy, metals,
agriculture, timber and water. Within the fixed income area, there were no
significant changes and we continue to maintain a shorter duration by overweighting
shorter-term bonds and underweighting long-term bonds.
All of us at S.R. Schill & Associates wish you and your
family a very happy holiday season and a happy New Year !
Bob Toomey, CFA®, CFP®Vice President, Research
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