Quarterly Investment Outlook: June 2017

SUMMARY

• Stronger domestic growth is needed to validate the expansion in p/e multiples since year-end, which is our base-case given 2Q17 growth is projected to be 3%.

• Inflation rates and breakevens have declined in 2017, but we view this condition as temporary.  Despite a moderation in U.S. economic growth, financial conditions remain accommodative and global activity has gained momentum.  Brexit talks could be contentious. Weighing all of the above, we see little reason for the Fed to alter its rate hiking path.  We continue to expect one hike in June to be followed by another in December.  The September meeting could feature preliminary discussions on downsizing the balance sheet.

• A rebound in economic growth and inflation will depend on an improvement in money velocity.  We are somewhat encouraged that the momentum of velocity is slowly improving.  An increase in business borrowing would accelerate this trend.  Loans and leases in all commercial banks are expanding at 3.9% yoy.

• We expect any correction to be brief, possibly to the 2250 level on the S&P 500, and to be followed by a resumption of the cyclical bull market.  Looking out into early next year, we see some potential dark clouds on the horizon.  Specifically we are concerned about the Fed's desire to reduce its $4.5 trillion balance sheet.  Should this result in a reduction in excess reserves, it would lead to a significant tightening in financial conditions.  Stay tuned!

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