While the Fed continues to increase short-term interest rates as the economy chugs along, we had a new wrinkle appear this quarter. Previously, long-term rates remained relatively stable as short-term rates rose. This had the effect of a flattening of the term structure of the yield curve, an indicator that future growth may slow. This month however, those stable long-term interest rates have begun to rise sharply in pace with short-term rates controlled by the Fed. The cause of this is quite unknowable at this point, but we note that oil and some commodity prices have been rising together with wage increases finally showing signs of life. The takeaway here is that the economy remains robust and that a slowdown or recession does not appear to be imminent.

Having said that, what about stock prices?

It is a fundamental investment principle that higher interest rates do not help rising stock prices. Aside from the interest expenses on cash flow and earnings, future earnings must also be discounted at a higher discount rate resulting in lower present values of those future earnings. However, much of the recent rising market can be attributed to stock buybacks of the largest corporations stemming from the recent sizable tax cut they received from last year’s tax reform. It appears that although the economy will continue to grow, the stock market may not be the same piggy bank it has been for much of the past decade where short-term interest rates remained near zero. It also appears to be increasingly susceptible to negative shocks from unexpected news events.

Back to economic growth. It took many years following the sub-prime financial meltdown for the economy to establish a solid foundation for sustainable growth by reallocating labor and plant resources as new technologies and efficiencies emerged. We now have a complex integrated economy at full employment firing on all cylinders on a solid and sustainable growth path. It appears that it will take more than gradually rising interest rates to affect or reverse that path barring other unexpected significant adverse impacts. As we’ve said before, economic expansions don’t usually die of old age.

We remain cautious and vigilant. Although we recently increased our cash positions, stock prices remain high and bargains are rare but we are always on the lookout for new and emerging sustainable growth technologies. Please also remember that because these quarterly thumbnail sketches are very brief, do not hesitate to call me if you wish to discuss your account or our outlook in greater detail.

Very Best Regards,

Joseph L. Toronto, CFA

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