Why does the stock market keep going up?
Leo Grohowski, chief investment officer at BNY Mellon, tried to explain the bank's outlook. As he travels around the country, he said, he hears the same question.
"There's still more than $2 trillion in cash not invested — and that's just in money-market funds," he told a crowd of financial advisers, attorneys, and clients last week at the Ritz-Carlton Hotel in Center City.
"There are still a lot of investors sitting on the sidelines, and each time there's a correction of even a few percent, more of that money comes rushing back into stocks," Grohowski said. "That may also explain the very low volatility" of the equity market, as the VIX falls to a 23-year-low of 10. (The VIX is an index Wall Street watches as a sign of worry, and when it drops to a low level, that's perceived as a sign of investor complacency about risks.)
What are we to expect from the economy in 2018? Here's the firm's thinking: after 2.2 percent GDP growth in 2017, 2.5 percent in 2018 — but less, about 2.3 percent, if there's no tax reform.
"There's not a lot of tax reform being discounted in the stock market. It's not baked in," he said.
Another conundrum besides the ever-rising stock market? Inflation.
"We're really not seeing it, and no one knows why — even [Fed Chair] Janet Yellen has called it a 'mystery,' " Grohowski told the audience.
BNY Mellon manages $1.6 trillion in assets, and Grohowski has been closely tracking the direction of interest rates, since "there's no playbook for the unwinding of the Fed's stimulative monetary policy that's been going on."
Granted, the core-inflation benchmarks the Fed scrutinizes "don't include a lot of costs we regular Americans pay, like college tuition and health care," he added. (For the record, he expects Kevin Warsh to be nominated as the next Federal Reserve chair, replacing Yellen.)
Do investors realize bond prices will fall when interest rates rise? They should, Grohowski warned.
"We've had a 30-year bull market in bonds, which may be coming to an end. If rates go up just 1 percent, we could see a 4 percent drop in the price of the 10-year Treasury," he estimated. "We're entering a coupon-minus environment, rather than the coupon-plus market we've experienced for so long."
However, not all fixed-income securities should be lumped in with Treasuries, he said, highlighting municipal bonds.
He likes many of them, but "don't be surprised if Pennsylvania is downgraded by other ratings agencies soon." Other munis, such as those backed by the Pennsylvania Turnpike Commission or University of Pennsylvania Medical Center bonds, yield more than the 10-year Treasury's 2.6 percent.
Speaking of the 10-year, Grohowski sees that particular Treasury yielding about 2.75 percent by year-end 2017 and 3 percent by the end of 2018 as rates rise. He expects two more rate hikes next year, as well as a rate hike this December. "That's the Fed normalizing."
Still, with rates rising, he advises investors to look out for interest-rate-sensitive securities in their equity portfolios as well — such as preferred stock, master limited partnerships, REITs, and utilities. "Also, some mutual funds that have a lot of income-producing companies in the portfolio behave like fixed income. Beware of that."
As for inflation, "low inflation has supported the current stock market valuation" of 20 times 2017 earnings. "Those valuations are allowed when inflation is low."
Look for dividend increases from some well-known names, he added. "Dividend payouts haven't kept up with earnings, and they're at historically low levels."
The South Jersey chapter of BetterInvesting (formerly the National Association of Investors Corp.) has announced that it will host an Investor Education Day Saturday at the Cherry Hill Public Library, 1100 Kings Highway N.
The session will run from 9:30 a.m. to 3:30 p.m.. Registration is $35 for the full-day workshop; lunch is included.
Learn how to look for companies selling at a reasonable price, and how to understand a company's prospects for growth and future sales and earnings. The event will introduce investors to the principles of the nonprofit BetterInvesting group; discussion will focus on joining an investing club and tax implications specific to New Jersey-based investors.
"This educational workshop has something for everyone," said Carla Krasnick, president of the South Jersey chapter. "We encourage individuals from the inexperienced to the more-advanced investors to join us."