Equity and bond markets posted positive returns for the quarter, which were spread evenly throughout.  Longer interest rates ended slightly down, giving fixed income investors a small boost.  First quarter earnings reports revealed a 14% year-over-year improvement, the best in over five years.  Supporting these gains was the best European growth in seven years, particularly benefiting domestic companies with large international operations.  The range comprising that average is wide with Financials up 20%, and Tech up more than 17%, while Utilities were up 5% and Telecom was down 5%.  This also explains the large gap between the increase in earnings and our own GDP.  We are encouraged to see our two economies finally moving in the same direction again and this supports our expectation for earnings growth of 8-10% through year end.

Among larger companies, revenue growth is picking up.  Using the S&P 500, average revenue growth over the last five years through Q1 2017 was 5.6%.  Over the final twelve months of that period it was 7.4%.  Since 2009 companies have better managed their expenses and bought back a great deal of their own equity, both of which contributed to rising earnings per share in the face of relatively flat revenue growth.  Increasing the revenue line provides a more direct and longer-lasting path to earnings growth and we believe this will continue for now.  Trading currently at 17.7x next years projected earnings, stocks remain reasonably priced. This should keep the stage set for continued equity appreciation through year-end, though perhaps at a slower pace than what we have enjoyed so far.

Politics remains front page news, but most of it is noise and of little consequence to equity markets.  Health care reform is still front and center with the Senate picking up where the House left off in March.  While health care requires some changes to put it on a sound, long-term footing, we are more interested in the upcoming corporate tax reform for the impact on equity values.  The Republican leadership will do everything in their power to produce legislation they can point to in the 2018 elections.  Without some governmental accomplishments to highlight, they will possess few arguments to employ in their campaigns.

We are now in the third longest expansion since World War II.  We only have to keep going another 25 months through July 2019 to surpass the longest one from March 1991 to March 2001.  With a duration like that, recession concerns invariably arise.  We are aware, but not concerned.  Typically recessions are led by speculative excesses.  While not an exhaustive list, the spectacular growth in equity prices leading to the 2001-02 recession, and the unchecked growth in mortgage debt that preceded the last recession, come to mind.

As we view the current landscape, few possibilities present themselves as concerns on the same scale.  In fact, this has been a thread in the primary complaint all along, that we cannot get economic activity going fast enough.  Which is what led central banks around the world to become so incredibly accommodative.  It is entirely plausible we will continue to produce a 2% average GDP growth rate well into next year, and possibly 2019.  In short, recessions are part of the business cycle and we’ll meet one eventually, but we don’t see one soon.

Sector performance diverged rather widely in the quarter.  In a reversal from prior periods, Health Care was the best performer, stemming largely from some overdue catching up.  Markets have spent the last two years advancing without Healthcare which, despite continuing to produce earnings growth, has remained essentially flat.  We are now seeing prices catch up to that earnings growth as the industry specific headwinds dissipate and political rhetoric softens.    Technology continued its strong run despite a selloff in mid-June.  On the bottom end, Telecom struggled as they consolidate further and seek to reposition themselves against unfolding competition in content and distribution.  And Energy suffered again as oil prices continue to decline from their February highs around $54 to just over $46/barrel.  Demand is holding up well; this is an oversupply problem.  U.S. production increases are overwhelming OPEC production cuts agreed last year.  While we enter a more cyclically positive time of the year for oil, secular changes in supply will most likely keep a lid on prices.

And now a review of our equity strategies.

Mitchell Capital All-Cap Growth advanced nearly 3% for the quarter and over 11% for the year.  We reduced energy exposure through the quarter, selling PDC Energy and Schlumberger entirely, and reducing Pioneer Natural Resources.  We still like the latter because of their shale sites in the Midland Basin and position on the production cost curve.  We increased exposure to Healthcare through purchases of Aetna and Thermo-Fisher Scientific, two well-run companies with attractive upside.  In addition to the catch-up factors mentioned above, they have moved past possible M&A tie-ups in managed care allowing insurers like Aetna to shift focus back to organic growth strategies.  Those factors, and more, will combine with reduced headwinds of the last two years, allowing more healthcare players to benefit regardless of what comes from the political arena.

Mitchell Capital All-Cap Value advanced more than 2% for the quarter and more than 5% for the year.  Activity was light this quarter.  We added a position in Alaska Air Group, which itself recently purchased Virgin Air.  Alaska Air offers quality service, a peer-leading cost profile, and has many ways to drive growth in an industry that is much more structurally sound.   We also purchased Amgen, a once fast growing company facing patent expiration and generic competition.  Management responded by growing its pipeline over the last several years with a number of promising new treatments through both internal research and M&A activity.

Mitchell Capital International Equity advanced over 7% for the quarter and more than 19% for the year.  We reduced positions in Adidas AG, Elbit Systems Ltd and Taiwan Semiconductor Mfg.   We still like these three names, but their values had advanced substantially, so we trimmed allocations and reduced their respective concentrations. We also added a small position in Astrazeneca Plc, a once fast growing company who faced its own patent expiration and generic competition.  Like Amgen above, management responded by building out its own pipeline over the last few years which we expect will deliver on a number of catalysts over the next 12-18 months.

Mitchell Capital Strategic Allocation advanced more than 2% for the quarter and more than 6% for the year.  The shift in first quarter to increase the large-cap allocation remains in place.  We continue to expect the mid- and small-cap allocation to help drive performance along with expected fiscal stimulus.

In fixed income the U.S. Treasury 10-year note started the quarter at 2.39% and ended the quarter at 2.30%, an odd outcome in the face of rising short-term rates.  Several explanations account for this.

After a strong second half last year, Q1 GDP came in at a relatively weak 1.4%.  Markets acted as if that was the last word for 2017.  This is short sighted.  Whether through seasonal adjustments or otherwise, the first quarter of each year since the recession has proven disappointing, only to be followed by stronger results over the remaining quarters that put average annual growth on track to 2%.  We expect the same for 2017, and estimates for Q2 GDP growth bear that out.

Inflation has stalled.  After headline inflation readings breached the 2% target in February, year-over-year price increases have slowly declined.  Whether a temporary or permanent phenomenon is still being debated.  The market is behaving as they did last summer, as if inflation is no longer a concern.  We think it is an overreaction.  While oil prices have softened on oversupply concerns, food prices are no longer the drag they once were and are rising.  Shelter costs are still in excess of 3%.  And while nationwide wage growth measures have advanced more slowly than expected under a 4.3% unemployment rate, specific geographic and product markets are showing evidence that broader wage growth impacts on inflation are on their way.  The Fed also thinks it temporary and is taking the long view as they continue pulling back accommodation.

The FOMC moved overnight rates again in June, raising the target between 1% – 1.25%.  They also released their plan to reduce the balance sheet with more detail than we expected, including the amounts and timing of the program. The only thing we don’t know is when they will start.  We think it will be in September.  Continuing to raise rates, coupled with letting maturing assets roll off, should add to upward pressure on rates. Taking the biggest buyer out of fixed income markets is not the time to hold long maturities.

2017 is unfolding largely as we expected.  Job growth remains solid, economic growth continues and inflation gains are taking a breather.