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Markets still trending upward but a correction looms

So far, it’s been a big year for investors, and the second half of 2017 should be similar – a strong one although the market could correct a bit.

Financial advisers are optimistic that the positive trends of the year’s first half will continue, barring any unforeseen events and with perhaps slight adjustments in the market. Those latter modifications could occur as reality replaces expectations created by the Trump administration and as the Federal Reserve increases benchmark funds rates.

“Expectations drive stock markets in advance of reality, and we may see a reality adjustment in the second half,” said Jonathan Moyer, financial adviser Moyer Insurance & Financial Solutions of Reading.

Michael Joyce, president of JoycePayne Partners of Bethlehem, also sees a good chance for a correction in the financial markets.

“However, at this point we don’t believe that a correction in the markets would be the beginning of a bear market, so we would likely ride out any correction that occurs in the near-term,” Joyce said.

Timothy Roof, assistant vice president with Valley National Financial Advisors in Bethlehem, also talked about the possibility of a short-term setback.

“If tax reform doesn’t meet expectations, we may experience a short-term pullback in the equity markets as volatility has been quite muted thus far in 2017,” Roof said. “As long as the consumer remains healthy, interest rates remain favorable, and earnings growth meets or exceeds expectations, the positive stock market trend can remain in place.”

INTEREST RATES AND INFLATION

Moyer said the Federal Reserve is expected to increase its benchmark funds rate, which may result in an increase in the interest rates on savings, bonds, loans and certificates of deposit.

“With the caveat that it took me six years to be partially right on interest rates, I think interest rates could drift modestly higher – especially if U.S. economic growth accelerates in the latter part of the year,” Joyce said.

With slightly higher interest rates, there could be a whiff of inflation, Joyce said.

“Real wages are increasing,” he said. “We’re not talking about 1979-1980 type of inflation but modestly higher than the past decade.”

HIKE IN WAGES, BUSINESS INVESTMENT

Consumer and investor sentiment is the strongest in years.

“Labor markets are tight, and there are real wage increases that are occurring, which bodes well for continued strength in consumer spending. Business investment, which had been abysmal, is showing signs of improvement,” Joyce said.

“Of course, you can have too much of a good thing because a pickup in in economic growth could also lead to more inflation, which, in turn, could beget interest rates that rise faster than the markets currently have priced in.”

STRONG BALANCE SHEETS

The VIX index, which is considered the “Fear Index” by many investors, has been low for a while.

“While it can continue to be low into the future, our view is that many good things [strong corporate earnings, tax reform, etc.] are priced into the market already, and policy missteps or an exogenous shock to the system could cause the market to pause or go into reverse,” said Kevin Karpuk of Cornerstone Advisors Asset Management LLC in Bethlehem.

“Unlike in prior market resets, there doesn’t appear to be the large financial imbalances in the system that would cause a meltdown that would not find a bottom at a painful, but reasonable level,” he added.

“Most companies have relatively strong balance sheets, which investors would find attractive at discounts from today’s price levels.”

FOREIGN STOCKS

For decades, U.S. stocks have outperformed non-U.S. stocks. However, that did not occur in the first half of the year.

That may continue in the second half, Moyer said, cautioning that everything is cyclical.

“International equity valuations still look attractive relative to the U.S. stock market,” Joyce said, “and investors would do well to have appropriate amounts allocated there.”

PRO-GROWTH EFFORTS

In the second half of 2017, investors should keep an eye on the progress of fiscal reform, corporate earnings and geopolitical events.

“If fiscal policy is able to deliver pro-growth reforms, it could help accelerate the pace of growth,” Roof said.

Advisers also are concerned about geopolitical risks such as the uncertainty of historical trade relationships.

“We don’t know where that will go,” Moyer said. “Throw in the uncertainty of North Korea and development of nuclear weaponry.”

INFLUENCE OF THE FED

Karpuk noted the importance of the Fed.

“The economy is sluggishly growing now, but if the Fed doesn’t maintain good balance in their goals of low inflation and low unemployment or the federal government can’t come to amicable solutions on the budget, debt limit, etc., there could be heightened risks in the market,” Karpuk said.

“On the flip side, if the consumer continues to spend and corporate earnings meet or exceed expectations, we can see continued profits in the market. Of course, in a year, there will be something that we didn’t discuss here that will impact the markets either positively or negatively.”

ECONOMY NOT POLITICS

Joyce cautioned about fixation on politics and the happenings in Washington.

“However, politics and policy speculation will have less impact – whether good or bad – than most people believe they will,” he said.

“At the end of the day, fundamental economic factors will have a more meaningful impact.”

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