Continued good economic news

The economic news continues to come in reasonably good.

Consumer sentiment, jobless claims, and manufacturing gauges are all continuing to be positive.

Good data also continue to come in from China and Europe.

European inflation for the first time since January 2013 hit 2%, a signal that the extraordinary actions the European Central Bank has been doing may be working.

The Japanese economy is also showing good numbers.  Inflation there turned positive in October and has remained positive.  Inflation is a sign of positive economic activity.

The global economy had been facing deflationary pressures for several years which are indicative of economic sluggishness.  Positive inflation numbers are a good sign.

With constructive economic data being reported around the globe, the prospects are good for the stock market to continue its path higher.  Having said that, the markets do not move in a straight line.

Stock market correction coming?

Each year there is a correction in the stock market.  I suspect this year will be no different.  In fact, the steep rise we have seen since the election makes it likely that the correction will come sooner rather than later.

Elections in The Netherlands, France, and Germany this Spring could also prove to be a speed bump for the markets.  If anti-Euro candidates are able to form governments, the markets will get nervous.

There is still Brexit looming out there.  The UK is likely to invoke Article 50 on March 31 and begin the divorce from the European Union.

Keep an eye on sentiment

It is always easier to make a list of bearish catalysts than a list of bullish ones.  I get nervous when I begin to read headlines like “Dow 30,000” and other signs of market euphoria.  There are still enough bears and enough money on the sidelines to outweigh the newly found exuberance but it’s important to keep eye on sentiment.

The Federal Reserve seems to be indicating that they intend to raise rates at this month’s meeting.  If the positive economic data continues, the Fed will be able to achieve its tentative goal of three rate hikes in 2017.

What shape will the yield curve take?

More important than the number rate increases, is what the shape of the yield curve will look like.

• If growth remains robust, then the curve is likely to be steep, which is a large spread between short-term rates and long-term rates.
• If the Fed raises short-term rates and the economy is just so-so, then the yield curve could flatten.

A steep yield curve is a help to the economy as it provides an incentive to lend and finance economic activity. Banks obtain deposits (borrow) at short-term rates and lend at long-term rates.  The difference in yield is the gross profit.

A flat yield curve is not supportive of economic growth.  If the spread is narrow, banks are not rewarded for taking risks and tend to refrain from lending.

There is a lot to play out in 2017.  I think stock prices end the year higher but the road to get there will probably be marked with ups and downs.

— Ian Green, Pendragon Capital Management

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Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.