As measured by Real Gross Domestic Product (GDP), the value of the production of goods and services in the United States advanced by an annualized growth rate (AGR) of 3.1% during the second quarter of 2017; an increase from the 1.2% AGR during the first quarter of 2017. During the second quarter, GDP was nicely divided between the economy’s goods producing sector and its services sector. The Gross Private Domestic Investment (GPDI) sector produces about 16.5% of the GDP and is vitally important to the growth of our economy. Most broad sectors in the GPDI section did very well, with only the residential sector detracting.
During its September 20, 2017, Federal Reserve Open Market Committee (the Committee) meeting, the Committee released the following statement, in part: “Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen, and that economic activity has been rising moderately so far this year. Job gains have remained solid in recent months, and the unemployment rate has stayed low... Hurricanes Harvey, Irma, and Maria have devastated many communities, inflicting severe hardship… past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further... In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.”
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. Transition from a soft growth economy (our current stage) to a moderately expansionary environment could trigger an allocation shift in our asset allocation models.
Monetary Policy: The Fed’s target range for the Federal Funds Rate (FF) is 1.00 - 1.25%; the Fed left the target rate unadjusted at their September 20, 2017 meeting. Near term, the effective FF has advanced, pulling itself closer to the Consumer Price Index (CPI). Additionally, money supply as measured by M2 and MZM have both fallen to below their historic mean levels. This movement could be caused by shifting economic activity, Fed policy, or both. Normally, a change from an accommodative stance to a neutral or restrictive posture on the part of the Fed features 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. Though the trend of Fed activity is towards a more restrictive stance, which could eventually dampen stock market momentum, the nature of their moves has been extremely moderate, which is why our view on monetary policy is still neutral for stocks.
Interest Rates: Both the 1-year T-Bill (1y TB) and the 10-year T-Note (10y TN) have marched upwards since early-summer 2016. The yield curve, as measured by the 10y TN minus the 1y TB, though, has remained relatively stagnant during that period at just over 1%.
Looking forward, we expect pressure on short-term interest rates to remain moderate along with inflation. If the economy continues to perform positively, long-term rates could see similar or greater pressure, 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: As of September 29, 2017, the S&P 500 index sits at 2,519. Our proprietary valuation work uses both fundamental and technical analysis and provides support for the S&P 500 at roughly 2,400. We believe the market is in fair-value territory. In order to create a band or range of equity market outcomes, we use a valuation tool which we refer to as our Proper PE ValuationTM tool. Among other things, this analysis provides us with a set of ranges above and below which we consider the S&P 500 overvalued or undervalued, respectively. Currently, our analysis suggests that an appropriate S&P 500 fair-value range is roughly 2,394 to 2,630. 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. Another 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 continued its trend reversal from last summer, telling us that the supply-side is beginning to put upward pressure on inflation. The Consumer Price Index (CPI) surpassed the Fed’s initial target of 2% earlier in the year and stayed there until May, when it posted a reading of 1.9%. There is moderate demand-side upward pressure on inflation. Until we see a steady CPI trend above 2% 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