2017-Part II - Janney Montgomery Scott LLC

2017-Part II July 3, 2017 Gregory M. Drahuschak At mid-year, many investors are conflicted about the deployment of investible capital. Do they hold and or buy more common stocks, or do they defer new purchases and possibly sell some of what they already own? Centuries ago, a famous resident of our Philadelphia home office city had a simple, but effective decision-making process. Faced with pros and cons of making a decision, using a quill and paper, Benjamin Franklin simply drew a horizontal line intersected by a horizontal line. On the left side of the vertical line he listed the reasons to do something and on the right he noted the reasons to delay or avoid taking an action. The side with the greater number of entries dictated what he did. An equity market version of the Franklin “T” is appropriate today. By mere item count, Franklin would look at the “T” count and buy more common stocks, but it is not totally fair to dismiss the items on the right side. The market’s valuation is relatively elevated with the S&P 500 trading at 18.75 times the 2017 earnings estimate; however, we suspect that the market is looking increasingly at a 2018 earnings number that based on early indication could be 11-12% higher than 2017, which would put the S&P multiple around 17. While this still is a relatively elevated valuation, it is important to remember that secular bull markets reach a peak at an earnings multiple at least several multiple points higher– some significantly higher.

GREGORY M. DRAHUSCHAK, VICE PRESIDENT

[email protected] 412.561.0497

WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC

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Rising interest rates often are not equity market friendly, but coming from today’s extremely low levels, the higher rates the Fed’s “dot plot” suggests are not enough to bring the equity market to its knees. In addition, based on comments by various Fed officials, we think the Fed will be extremely sensitive to any negative impact of their rate actions and probably would be willing to reverse any credit tightening if needed. It has almost become a cliché, but it is true that major bull markets do not succumb to old age. The current stock market is the second-longest (1990-2000 was the longest) and fourth-strongest for the S&P 500; however, economic and corporate fundamentals not the calendar will determine the bull market’s longevity. The lack of a major correction does leave the market vulnerable to a pullback, but any such event should not be considered to be the start of something more severe. In fact, we would view a pullback with enthusiasm as a chance to bolster equity ownership. The last three reasons to avoid stocks - federal government policy uncertainty, geopolitical risks and high complacency - are difficult to refute since they all could derail the market temporarily or for a long period; however, none of these are sufficiently quantifiable to be an important component of a decision matrix. To the contrary, depending upon events associated with each item, they could move to the left side of the “T”. Passage of a tax reform plan, corporate tax rate reduction and repatriation of foreign held profits could be major catalyst to thrust the market higher. Complacency often is measured by the VIX Index, which shows the market's expectation of 30-day volatility, is very low. A common interpretation of this is that the market is not giving appropriate consideration to risks and therefore could find investors ill-prepared if a disruptive event occurs. However, through much of the bull market move the VIX has been low relative to its long-term norm. Also, we find that in recent years the VIX has been less reliable as a guide to market movement than when initially constructed in 1993. One of the reasons to maintain or add to equity positions often is overlooked. The number of publicly owned companies has declined sharply from the 1997 peak. Initial public offerings fall well short making even a modest dent in this decline. At the same time the amount of potentially investable cash has risen dramatically. From a purely supply-demand standpoint, there could be constant buying pressure that can send the major averages to higher levels while limiting the extent of interim market pullbacks. Admittedly, the items on the left side of the “T” are not static. As always is true, paying attention to notable changes in any of the items is important, but we think Mr. Franklin would agree that the weight of the evidence suggests maintaining a high level of equity participation. **************************** For many investors July and August are most closely associated with vacations than major market gains. However, since 1949, both months show the S&P with a modestly net positive bias with the S&P 500 posting a gain in 37 of the 67 years. July on average produces the fifth best average percentage gain of all months a while, August on average has been the second worst month of the year with a small average loss. This month, Washington D.C. policy decisions could exert major influence on the equity market. Stretched technical conditions in some major market indices could subject them to increased volatility if major policy

GREGORY M. DRAHUSCHAK, VICE PRESIDENT

[email protected] 412.561.0497

WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC

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initiatives fail to achieve the results investors have hoped for since the November election. Technical factors, however, continue to suggest that any interim pullbacks will relatively shallow. Results of the Comprehensive Capital Analysis and Review (CCAR) of major banks allowed them to implement significant capital returns through increased cash dividends along with stock buybacks. This reinforced our pre-existing positive bias toward the financial sector. Nearing the end of the first half, the technology sector faced a bout of substantially heighted volatility, but we would be alert for entry points into this still appealing sector. Energy, industrials, and healthcare continue to be attractive also. As has been true for several weeks, the market is vulnerable to a pullback, but we would use this as an opportunity to add to equity positions. With no glimmer of a recession in sight and improvements overseas, the current economic and market cycle could continue well into 2018. Global equity markets began this week solidly higher. For example, the IHS Markit Eurozone final manufacturing PMI was revised to 57.4 in June from 57.0. The pushed the rate of expansion in the Eurozone manufacturing sector to a 74-month high. The headline number was driven by rise in inflows of new orders, which left job creation close to May's 20-year survey high. Production and new orders expanded at the quickest rate since the first half of 2011. Oil resumed its late-June upswing with West Texas Intermediate crude pushing toward $47 a barrel. The 2017 S&P earnings estimate increased by a nickel last week to $130.14. For the 2nd quarter. the estimated earnings growth rate for the S&P 500 is 6.6%. Nine sectors are expected to report earnings growth for the quarter. So far, 76 S&P 500 companies have issued negative 2nd quarter earnings guidance and 38 S&P 500 companies issued positive guidance. Following the report last week that Chicago PMI last week that hit its highest level since late 2014, the ISM Index kicked off this week’s economic data with its highest reading since November 2014. The New Orders Index at 63.5 percent was 4 percentage points above the May reading. The Production Index rose 5.3 percentage points and the Employment Index increased 3.7 percentage points. This week has a relatively busy calendar of economic data highlighted by Friday’s employment report, but minutes from the most recent Federal Reserve Open Market Committee (FOMC) will get attention to see if they offer hints of what the FOMC will do with credit policy. Have a great week. GREGORY M. DRAHUSCHAK, VICE PRESIDENT

[email protected] 412.561.0497

WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC

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GREGORY M. DRAHUSCHAK, VICE PRESIDENT

[email protected] 412.561.0497

WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC

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