Let Me Hear Your Balalaikas Ringing Out Come and Keep Your Comrade Warm

April 17, 2017 – DJIA = 20,453 – S&P 500 = 2,328 – Nasdaq = 5,805
“Let Me Hear Your Balalaikas Ringing Out Come and Keep Your Comrade Warm”[i]
The history of Russia spans over 1,100 years.  As expected with anything that has this longevity, it’s not been a smooth journey.  They have been responsible for historic cultural advancements in art, literature, architecture, and science.  Unfortunately, the lows include revolution, conquest, corruption, oppression, world wars, and cold wars.
Surrounding the U.S. presidential election, Russia became the target of the Democrats’ disdain as they were blamed for Hillary Clinton’s defeat.  The election was close in many key states so anything that swayed votes influenced the outcome.  However, without giving a pass to Boris and Natasha, there are many other scapegoats with several being internal.
Of course, more recently, the list of Russian detractors includes Team Trump which was originally criticized for allegedly being aligned with Moscow.  After Nikki Haley’s United Nations tongue lashing and President Trump’s decision to bomb Syria, it’s safe to assume there are not any White House dinner invitations addressed to Vladimir Putin.  Or vis-a-versa.
Global tensions have risen which is causing some unexpected coalitions.  President Trump has back-peddled a bit on the campaign rhetoric concerning China.  Given Chinese influence over North Korea, issues such currency manipulation and trade imbalances were not on the agenda when Chinese President Xi recently met with Mr. Trump.
Unexpectedly, headlines about Syria, Russia, North Korea, ISIS, and other geopolitical problems have not derailed the stock market.  Admittedly, the major averages have pulled back from the records reached at the beginning of March.  But most would have anticipated much lower prices after the news of bombs in the Middle East together with the unstable Kim Jong-un testing nuclear missiles.  Instead, the 2017 version of the U.S markets take this news in stride.  Whether this is whistling past the graveyard is unknown.  Here are where the major indexes are year-to-date.
                                                                                  2017 YTD
Dow Jones Industrial Average                                    +3.5%
S&P 500                                                                      +4.0%
Nasdaq Composite                                                      +7.8%
Russell 2000                                                                -0.9%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
A couple of noteworthy nuggets from the current market landscape.  We draw your attention to the numbers above to highlight that the Russell 2000 finished last week lower for 2017.  As a reminder, the Russell 2000 was the best performing index in 2016 and was especially strong after the election.
On the other hand, the Nasdaq is the strongest of the major indexes through the first 3 ½ months.  Returning to 2016, this was the weakest of the bunch after the election as investors were convinced that Trump’s immigration restrictions would be an obstacle to technology related businesses.
Combining these two reversals, this could represent a rotation from small caps (Russell 2000) to technology (Nasdaq).   It could also be a correction of the solid 2016 gains for the Russell.  Once again, this reminds us that past performance is no assurance of future results.
A common commandment at the start of 2017 was that interest rates would be moving higher.  Indeed, the 10-year Treasury yield, which closed 2016 at 2.43%, rose to 2.61% in March.  Since then, however, bond yields have fallen.  The 10-year finished last week back at 2.23%.
This surprising rally for the bond market (lower yields = higher bond prices) is partially caused by the lowering of 1st quarter GDP estimates, delays in tax reform and regulation cutbacks, and lower inflation. And let’s not forget that the U.S. Treasury market is viewed as a safe haven.  With bombs falling and international tensions high, it makes sense that some global capital flows to U.S. government debt.
Another explanation might be that this move lower in bond yields is a function of how one sided the market had become.  After the election, investors believed that the economic growth would pick-up driven by reduced regulations and increased infrastructure spending.  These additional fiscal programs would be theoretically financed by higher government deficits.  Higher yields would be required to entice buyers of these newly issued bonds.
The result was a crowded investment.  Markets are the summation of investor opinions.  If everyone believes that rates were going higher, prices reflect this. If the market becomes too one-sided, in this case everyone bearish bonds, there are fewer and fewer sellers.  Once the sellers exhaust themselves, the market has to move the other way in order to regain balance.
A final point on the fixed income market.  At the same time that longer term interest rates are falling (10- year and 30-year bonds), the Federal Reserve is raising the short maturity rates (federal funds).  This flattening of the yield curve is often a sign of a sluggish economy.  This is case, however, it might be the necessary rebalancing of the bond market which includes the punishing of the bond bears.
The capital markets have had a lot to digest recently.  And there more on the way – French elections this weekend, British elections in early June, first quarter earnings, and the steady stream of presidential tweets.  Of course, the geopolitical landscape can throw in a knuckleball any time.

It is a bullish sign that the global markets have navigated the recent cross currents without a more prominent pullback.  Nevertheless, this remains a highly-valued market facing a lot of uncertainties.  This skinny margin of safety won’t be problem as long the economy expands, the Fed doesn’t raise interest rates too fast, France stays in the EU, the fleet of U.S. aircraft carriers can cover all international calamities, Congress accomplishes something, Amazon becomes the only retailer left, and the New York Jets don’t do anything too stupid in next week’s NFL draft.  That’s not too much to ask for!

Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905

[i] Lennon-McCartney, 1969
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