MONTHLY FINANCIAL MARKET UPDATE
The summary below is provided for educational purposes only. If you have any thoughts or would like to discuss any other matters, please feel free to contact me.
The Waiting Game
Much of the optimism over the last three months can be traced back to the themes that have been running since Election Day.
It’s a new administration that wants corporate tax cuts, individual tax reform, regulatory reform, higher defense spending, and a ramp-up in infrastructure spending. With the exception of new domestic outlays, the Trump administration is working with a sympathetic Congress.
Yet, it’s also an administration that has railed against globalism and has shunned large, multilateral trade deals. Markets like the former; they cast a wary eye on the latter.
For now, it’s not just investors that have warmed to the change in Washington and the perception that business-friendly legislation is just around the corner. First, let me state the obvious. The name Donald Trump elicits a myriad of reactions. Yet, surveys of consumer confidence have soared since the election, with the Consumer Confidence Index hitting its best reading in 15 years – see Figure 1.
Data Sources: Conference Board, Polling Report, NBER
Shaded areas mark recessions Last Date: Jan 2017
Moreover, a measure of small business confidence is at its highest level in over a decade (National Federation of Independent Businesses). One might say that the ‘animal spirits’ that drive economic activity are stirring.
Still, major proposals designed to create a more fertile ground for economic growth don’t happen overnight.
Washington moves slowly and competing interests can complicate matters. For example, talk of a “border adjustment tax” is a new wrinkle that just popped up on the horizon. But investors want a simple and clean cut in the corporate tax rate, dropping it from 35% to around 15-20%. In some respects, January has been an interim period – a waiting period. It’s one where investors have been trying to evaluate how the new administration will govern, what its priorities will be, and how it will move forward.
Following a strong finish to 2016, we saw the upward momentum in shares slow through much of the month. However, the Dow did top 20,000 for the first time when Trump got back on message (at least from a market perspective), meeting with business leaders and signing executive orders designed to speed energy pipeline construction and pare back on what he sees as burdensome regulation.
Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC
*Monthly: December 30, 2016 – January, 31 2017
Remember, it’s the pro-growth message we heard in November that sparked the rally in shares.
Still, Trump was not a conventional candidate, which was part of his appeal in some corners. And he has yet to shed his unorthodox ways. He’s not shy about tweeting his opinion or ruffling feathers.
Some like the new style. Others abhor it. As your financial advisor and financial confidant, I’m not here to offer opinions on his leadership, or use this space as a political platform.
My goal is to discuss themes that are affecting shares in either a positive or negative fashion. It’s to view what’s happening through the narrow prism of an investor. I’ll leave it to you to form your own conclusions regarding the broader aspect of his policy initiatives.
President-elect to president
Investors crave a fair degree of certainty. They want quick enactment of pro-growth policies. The roll-out of his more controversial stances, including the restriction on immigration, created political uncertainty and some turbulence as the month came to a close.
It not only raises fears that Trump may get sidetracked, but there are rising concerns the pro-business message heard in November and the laser-liker focus on taxes may end up taking a back seat to other proposals and squabbling among Congressional leaders.
Given the impressive run-up since Election Day, short-term traders used the political uncertainty as an excuse to sell as the month came to a close.
Long-term focus – the fundamentals
Longer term, it’s really about profits and profit expectations, economic growth, and interest rates.
The four-quarter earnings recession has ended, and earnings growth is forecast to accelerate and run above 10% in 2017 – see Figure 2. You have to go all the way back to early 2011 to find four-straight quarters of double-digit profit growth (Thomson Reuters).
Data Source: Thomson Reuters Last Date: 1.30.17 Forecasts are subject to change.
Of course, earnings forecasts are subject to change given that there are plenty of moving parts in the earnings forecast equation, including U.S. and global economic performance and the dollar.
Moreover, firms are posting profit margins that are near record levels (S&P Dow Jones Indices). An acceleration in wage growth would be welcome. So would a rise in business investment, but it would likely whittle away at margins. Of course, that would likely occur in response to faster economic growth, which is a tailwind for profits.
As you can see with this simple example, forecasts rely on plenty of changing variables.
Meanwhile, the economy continues to expand, and the Fed currently believes that gradual rate hikes are the most likely path.
Volatility can’t be ruled out. It is a natural part of investing. Risk can be managed but not eliminated. For now, the fundamentals are generally supportive of shares.
Christopher J. Carroll, CIMA®
Founder, Portfolio Manager, and Founding Partner