Financial markets saw healthy gains during the first quarter of 2017. In the US, the Dow Jones Industrial Average reached 20,000 for the first time on January 25. 20,000 is a symbolic number that perhaps eases investor fear lingering from the 2008-2009 financial crisis. Growth stocks outperformed value stocks, and large caps fared better than small caps in the first quarter. International and emerging market stocks performed better than US stocks. Interest rates remained steady, allowing for modest, but positive, returns for bonds. The only negative performers were international bonds and commodities.
In the US, stocks continued their post-election climb dubbed the “Trump rally”. Investors expect a positive environment for businesses from a Republican-controlled White House and Congress. Consumer confidence rose in March to a level not seen since December 2000. Late in the quarter, markets cooled as key healthcare legislation failed to achieve enough support to pass the House. President Trump previously stated that healthcare must come before tax reform.
Delivering on his campaign promise of less regulation, President Trump ordered a review of the Dodd-Frank financial regulation and the DOL Fiduciary Rule on February 3. The Fiduciary Rule required that financial advice given to investors with 401(k) or IRA retirement accounts be in their best interest. Currently, the DOL rule is under a 60-day delay. Regardless of the outcome, the DOL Fiduciary Rule has let the “cat out of the bag” with regards to the best interest standard for retirement advice. Many of the largest financial services firms have already made changes to reflect the intent of this rule.
Household Net Worth
In the Federal Reserves’ latest Flow of Funds report, we learn that US household net worth reached a record $92.8 Trillion at the end of last year. Breaking down household assets further, we learn that 21% of US household assets ($23 Trillion) are in our homes. And most strikingly, 10.5% of US household assets are sitting in cash. This $11.4 Trillion in cash is divided among checking accounts, time deposits, and money market funds, all earning close to zero interest.
As the Fed continues to raise its policy rate, interest on cash and money market accounts will also rise. An increase of 1.00% on these cash reserves generates approximately $114 Billion in interest each year. This is no drop in bucket and could have positive economic effects if households spend the extra earnings or choose to invest it in stocks. Of course, pulling cash off the sidelines completely to invest in the stock market would have a dramatic effect. It is a shame if long-term savings have been parked in low interest savings accounts.
One additional piece of information in the Fed report is the size of student loan debt outstanding. US households currently owe $1.4 Trillion in student loan debt. This is a hefty bill. Student loan debt may hinder young Americans from buying homes and starting families for years to come.
For the first part of 2017, the US economy continued to hum along slowly. Despite a drop in March, the US economy created 533,000 jobs during the first three months of the year. This level of job creation is on pace with the last several years. Initial jobless claims, the number of newly laid off workers applying for unemployment benefits, fell to the lowest level in 40 years in late February. The third and final revision for fourth quarter 2016 GDP (Gross Domestic Product) was released on March 30. Real GDP grew at an annual rate of 2.1% for the quarter. In February, new housing starts hit a level not seen since before the financial crisis.
Generally positive economic data, combined with inflation near the 2% target, led the Federal Reserve to raise its policy rate to 0.75% -1.00% in March. In its press release the Fed Board of Governors noted; “the labor market has continued to strengthen and economic activity has continued to expand at a moderate pace.” The consensus expectation is that the Fed will raise rates two or three more times in 2017, bringing the Fed Funds rate to 1.50% – 1.75%.
We Just Can’t Help Ourselves
I recently read Michael Lewis’ latest book “The Undoing Project”. The book is about Amos Tversky and Daniel Kahneman, the originators of the field of behavioral economics. In it, Lewis reveals how Tversky and Kahneman identified heuristics (mental shortcuts) people use to evaluate potential losses or gains. Humans tend to be risk averse when faced with gains and risk seeking when dealing with losses. Try answering the following questions:
Which of the following do you prefer?
- A certain gift of $500
- A 50% chance to win $1,000, or 50% chance to win $0
Which of the following do you prefer?
- A 50% chance of losing $1,000, or 50% chance of losing $0
- A certain loss of $500
Most people chose #1 and #3.
We are willing to gamble when faced with losses but prefer certainty with gains. The $11.4 Trillion sitting in cash today represents our collective risk aversion when facing gains. We prefer the certainty of 0.05% in a money market to the uncertainty of the stock market. And yet this same group of investors will exhibit risk seeking behavior when faced with certain losses. A perfect example is holding on to a stock that recently dropped 80%, while waiting for the investment to “get back to even”. We’ve all done it, right? To avoid the pain of that loss, investors continue to hold the stock even though there are better investment opportunities.
Behavioral economics will influence investment advice to a much greater degree in future years. As we learn about the numerous ways that the human mind can’t help but make irrational choices, we identify potential opportunities to improve investor outcomes. Talk about learning from our mistakes!
Blair duQuesnay, CFA, CFP®
 “Consumer Confidence soars in March to highest level since December 2000”, Wojcik, Natalia, CNBC, http://www.cnbc.com/2017/03/28/us-consumer-confidence-hits-1256-in-march-vs-estimate-of-114.html
 “Financial Accounts of the United States: Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts”, Fourth Quarter 2016, March 9, 2017, page 138.
 “U.S. Jobless Claims Lowest Since March 1973”, Sparshott, Jeffrey, Wall Street Journal, March 2, 2017.
 “Housing Starts Rise to 10-Year High”, Kusito, Laura and Leubsdorf, Ben, Wall Street Journal, March 16, 2017.
 Federal Reserve press release, March 15, 2017 at 2:00pm.
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