Q3 2016 Market Commentary
David Y. Sun, CFA®

In the spirit of the Presidential Debates, let us use Reagan’s famous expression, “There you go again,” in describing the recent round of fixation on interest rates. It was only after the Fed’s announcement in September to hold rates steady that interest rate sensitive investments recovered from being under pressure. The reemergence of this downward pressure can be seen in the beginning of the 4th quarter, especially within the utility sector, REIT’s and dividend yielding stocks. We expect these areas to recover, as they did in the latter part of September, but also believe the upside from recent highs may be limited in the near-term.

When we experienced the “Taper Tantrum” in 2013, we were taking the positive perspective on the “half empty or half full” scenario, contrary to the overall market. Our preference was to see rates driven by market forces versus the Fed’s bond purchasing program. Therefore, we viewed the termination of the QE efforts as a positive. Even when the 10 year rate spiked above 3%, evidence of inflationary factors supporting the increase could not be found. In hindsight, remaining calm was the right decision since the 10 year rate is currently around levels prior to the “Taper Tantrum,’ even after a rate increase last December.

Let’s evaluate equity markets in the same manner. Many analysts believe we are in an interest rate driven market where valuations are at a premium. These same professionals view higher rates as a threat to current valuations and the prospect of a rate increase by year-end continues to cause concern. Based on fundamentals, we do agree that markets are trading at a slight premium relative to our support level of 17,550 for the DJIA in 2017. But our perspective on the next rate increase is different. If the Fed’s decision is executed correctly, it should signify strength in the economy, which would have a positive effect on corporate fundamentals. This should enable equity markets to transition from being interest rate driven to being driven by fundamentals which is more desirable.

In this type of scenario, we believe that growth stocks will take the lead and value (dividend yielding) stocks will lag behind as fundamentals catch up to support current valuations. Again, the question here is when will this transition occur? Even though economic signals remain positive, patterns can be confusing at times, especially when you’re trying to identify trends based on monthly data. We still don’t see overwhelming evidence at this time for higher rates but those who fear the possibility of a recession due to a later (and greater) rate increase would prefer a pre-emptive strike. The premise for such a decision is predicated on the economy growing at an accelerated rate driving inflation which we also do not see at this time. While others continue to focus on interest rates, our attention is directed to a stronger U.S. Dollar and its impact on corporate earnings.

Finally, a reminder that our Annual Wine & Cheese Event will be held on November 17th. Please reach out to Leslie Tritschler at 484-320-6300 for additional details. We hope to see you there to help celebrate the expansion of our office space.

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