As measured by the Real Gross Domestic Product (GDP), the value of the production of goods and services in the United States (US) advanced by an annualized growth rate (AGR) of 2.1% during the fourth quarter of 2016. This was a decrease from the 3.5% AGR during the third quarter of 2016. The Federal Reserve (Fed) continues to see stronger economic activity, including improving labor market conditions and inflation, as measured by the Consumer Price Index, moving past their stated target. During its March 15, 2017 Federal Reserve Open Market Committee (the Committee) meeting, the Committee released the following statement, in part: “In view of realized and expected labor market conditions and inflation the Committee decided to raise the target range for the Federal Funds rate to 0.75 – 1.00%. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2% inflation… The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”
Many economic statistics we track, both in terms of consumption (demand) and production (supply), are currently showing positive trends, suggesting we may be transitioning towards a sustainable expansionary stage of economic activity. Moderate expansionary environments generally mean that both production and consumption would be expected to continue pushing the economy forward, yields would potentially rise and GDP could see moderate-to-robust growth. A shift from a soft growth economy towards a moderately expansionary environment could trigger an allocation shift in our asset allocation models.
Monetary Policy: The Fed’s target range for the FF is 0.75 – 1.00%. Notably, the Fed asserts that it remains accommodative even though it has increased the FF rate twice in the past year. We believe there are two main reasons the Fed considers their position to be accommodative even in the face of rising rates: first, over the near term, the Fed will most likely allow short-term measures of the money supply to continue to grow near their historic mean; second, the FF rate is still well below the inflation rate as measured by the Consumer Price Index (CPI). Normally, a change from an accommodative stance to a neutral or restrictive posture includes a FF rate above both short-term treasuries and the CPI. The Fed’s recent actions and its planned policy response to future economic metrics will likely be measured. Therefore, while they have begun the process, we believe the Fed will take its time unwinding its expansive balance sheet, leaving the banking system well capitalized for lending to the private sector. While activity is restrictive, and could eventually dampen stock market momentum, the nature of the Fed’s moves has been extremely moderate, which is why our view on monetary policy is still neutral for stocks.
Interest Rates: The yield curve, as measured by the 10-year T-Note (10y TN) minus the 1-year T-Bill (1y TB), has begun to make a marked increase. Expansion of the yield curve beginning towards the end of 2016 has seen 10y TN increasing by just over 1 percentage point, while 1y TB increased by about 40 basis points. Expansion of the yield curve is likely due to the strengthening economy and a modest increase in inflation. Looking forward, pressure on short-term interest rates is beginning to build as inflation mounts. If the economy continues to perform positively, long-term rates could see similar or greater pressure, further expanding the yield curve. The current level and trend of the yield spread has, in the past, correlated closely to the stock market performing near or slightly better than its long-term central tendency.
Regarding long-term corporate bonds, the quality spread is declining as lower-rated bonds are falling in yield slightly faster than higher-rated bonds. A quality spread in this position is generally positive for both the economy and the stock market.
Equity Valuations: Our proprietary technical work provides support for the S&P 5001 at 2,283, while the index is at 2,362 as of March 31, 2017. This puts the S&P 500 valuation in our fair-value range. To us, fair-value means the stock market should perform within the parameter of its historic mean. The current level and direction of many economic statistics we enter into our valuation algorithm indicate that we are likely to stay in fair value range for the near-term. We are watching corporate earnings growth closely, as changes in earnings data has the potential to change valuation levels quickly.
Inflation: One of the reasons we expressed an expectation of restraint from the Fed in our interest rates discussion is our view of inflation, which we think should remain at a moderate rate of growth over the intermediate term. Historically, the employment private service providing sector’s (EPSP) weekly earnings 12-month percent change and its direction have correlated well with CPI. CPI has been trending up from the middle of 2015, and it has come close to the EPSP level, which has likewise been trending positively since May 2015. Anther sector that has a long-term effect on inflation is the manufacturing sector. When there is strong pricing pressure from the manufacturing sector it tends to lift most associated prices; this tends to help wages grow, triggering an inflationary cycle. Currently, these metrics are modestly affecting inflationary pressures in our economy. The Producer Price Index (PPI) has recently reversed trend, telling us that costs (supply-side) are beginning to put upward pressure on inflation. Likewise, there is moderate demand-side upward pressure on inflation. Over the past few months, the Consumer Price Index (CPI) has reached and surpassed the Feds initial target of 2%, reaching 2.7% in February 2017. As we see a steady trend above 2% and a modifying of the Fed’s balance sheet we believe that the Fed will be cautious about adjusting its monetary policy.
1The S&P 500 is an unmanaged, capitalization-weighted index. It is not possible to invest directly in the S&P 500.
Information contained herein was obtained from recognized statistical services and other sources believed to be reliable and we therefore cannot make any representation as to its completeness or accuracy. Any statements not of factual nature constitute opinions which are subject to change without notice. Past performance is no guarantee of future performance. Investors should carefully consider the investment objectives, risks, charges and expenses of the Saratoga Funds. This and other information about the Saratoga Funds is contained in the prospectus, which can be obtained by calling (800) 807-FUND and should be read carefully before investing. The Saratoga Advantage Trust’s Funds are distributed by Northern Lights Distributors, LLC. 1/17 © Saratoga Capital Management, LLC; All Rights Reserved. Saratoga Capital Management, LLC is not affiliated with Northern Lights Distributors, LLC, member FINRA/SIPC. 6581-NLD-4/20/2017