Equity markets started the year on a strong note, with many indexes hitting new all-time highs. International and technology stocks were the strongest performers as many of the market leadership trends from late 2016 reversed. Markets continue to ignore any negative headlines that aren’t expected to have a significant impact on the economic outlook. The Federal Reserve raised its target for short-term rates again and many economists expect them to raise rates 2 or 3 more times this year. Although short-term rates rose in response, intermediate rates were generally stable, helping bond returns for the quarter.
The U.S. economy looks like it hit another soft patch in the first quarter as preliminary reports indicate growth was weaker than expected. Construction spending, car sales and consumer spending ended March on weak notes, although other economic data has been stronger. Declining credit creation in both consumer and busi-ness markets is also a concern. As in recent years, any improvement in year over year economic growth will have to come from the next three quarters. The global economy is showing signs of improving in recent months and there are no early signs of an imminent recession. Combined with a stable U.S. dollar, this is good news for U.S. based multinationals.
Europe is headed into uncharted territory as the U.K. triggered the beginning of the two year process of with-drawing from the European Union. Nobody knows how the process will unfold or how long it will take the U.K. to negotiate new relationships with the rest of Europe. Any major changes could have a negative economic impact on a region that has struggled for years to accelerate economic growth. Geopolitical risk remains elevated with new terrorist attacks in Europe and developments in North Korea and Syria dominating headlines.
While developments in Washington are important and require close monitoring, eventually economic fundamentals and company earnings will drive stock market valuations. By many measures, equity valuations are stretched and appear to be pricing in very optimistic earnings and economic growth scenarios. With interest rates well off their lows and the Fed looking to continue raising its target for short-term rates, equity valuations are dependent on strong growth in earnings going forward. If the recent spike in consumer and business confidence ultimately translates into more spending and investment, stocks can continue to move higher. Most analysts are projecting strong earnings growth this year. In recent years, however, analyst forecasts of full year earnings have declined steadily throughout each year. We will be watching reported and projected earnings over the next several quarters to see if actual earnings can match current expectations