March 2017’s employment statistics gave the Fed plenty to cheer about as the unemployment rate fell to the lowest level in over 10 years to 4.5% while the 12 month change in average hourly earnings was 2.7%. As other measures of inflation now approach the Fed’s 2% objective, Yellen and Co. can safely claim “Mission Accomplished!” as both prongs of their dual mandate – full employment and contained 2% inflation – have been attained. Although naysayers would argue that the labor participation rate remains stubbornly low, it too has been gaining over the last few months as the now persistent +2.5% wage growth pulls in workers from the sidelines. Unfortunately, this magical economic state is static and provides our data-dependent Fed further justification for tinkering with rates, adjusting its balance sheet and utilizing other policy tools to “manage” the economy. To this end, the Fed further normalized interest rate policy in mid-March lifting the Fed Funds target to 1%. Anticipating continued economic strength, the Fed expects two additional rate hikes this year and potentially shrinking its bloated $4.2 trillion balance sheet. As all good helicoptering parents know, just as you take your eye off your dependents, they get into trouble. With this in mind and a likely more cyclical economy moving forward, I am sure our Fed will monitor each data wiggle intensely.

Expectations vs. Reality on Economic Growth

Post-election and into 2017’s first quarter, U.S. sentiment data soared as consumers, CEOs, small business owners and investors optimistically anticipated stronger economic growth on the shoulders of proposed tax reductions, less regulation and improved trade terms. In March, The Conference Board’s CEO Confidence Index surged to 68, its highest level since 2004 and the Consumer Confidence Index rose to its highest level since December 2000. Historically, high and rising levels of this “soft-data” have been followed by outsized capital expenditures and purchases of consumer durables. Thus far, however, soft data gains have not directly translated and, as such, there is a building divergence of expected GDP gains based on the underlying algorithms of the modeling tools. For instance, the Atlanta Fed’s GDPNow model currently shows real GDP rising by only 0.6% during the first quarter, while the New York Fed’s NowCast model forecasts a 2.8% advance. While both the ISM Manufacturing and Non-Manufacturing indexes declined modestly from high levels in March, the sub-components of each show broad advances. Taken together, Yardeni Research estimates that the combined readings of the two ISM indexes correspond to a 2.6% annualized real GDP.

Invest Abroad!

Do it, for no other reason than it may be time to rebalance your portfolio. For the five years ending 2016, the Russell 3000 — a broad-based, capitalization-weighted index of U.S. equity prices — soared 14.67%/year, sharply outperforming the MSCI All Country World ex U.S.A. Index which only gained 5%/year. Investors who originally crafted a balanced equity portfolio of 80% U.S./20% International in 2011 are now meaningfully out-of-whack as the weightings, if untouched, would now be 86%/14%. As you expect, valuations abroad in both developed and emerging markets remain historically cheap compared to the U.S. and economic acceleration is becoming a globally synchronized event. At the end of March, the MSCI EMU had a forward P/E of 14.6 — a discount of 19% — compared to the U.S. MSCI forward P/E of 18.0. Importantly, expansionary Purchasing Manager Indexes (PMIs) are not just a U.S. phenomenon as the Global Composite PMI at 53.8 approaches its 22-month high. I am guessing that relative international equity outperformance in the first quarter (ACWI +7.92% vs. Russell 3000 +5.52%) is the beginning of a longer trend.

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