Much has been made of President Trump’s expectation to implement his pro-growth agenda, which certainly contributed to the run-up in equities starting immediately after the election. However, recent market strength seems to result more from positive corporate earnings than anything else, which, on balance, is a more essential driver of equity returns. Furthermore, the Trump administration has yet to produce specifics about its tax goals while health care reform is taking much longer than anticipated. At the same time, ongoing investigations into the White House are, at a minimum, creating serious distractions. Investors still expect a tax bill, but the odds are diminishing of anything comprehensive being passed this year.
Through the first quarter, U.S. companies grew at their fastest pace in nearly six years, extending the stock market rally that has stretched into its ninth year, which began March 2009. Analysts polled by FactSet also estimate the broader indices will post earnings growth of 6.8% for the 2nd quarter and 11% for the full-year.
The gains were not only strong, but additionally broad, coming from numerous sectors including heavy equipment engineering, banking, consumer goods, and social networking. The strength and quality of earnings offers investors a welcome contrast with previous years in which it appeared that stock gains were resulting more from ultralow interest rates buoyed by the QE programs and corporate share buy-backs rather than earnings growth. Within the past year, share buy-backs by S&P 500 companies declined 24%, based on about a third of S&P 500 companies, according to S&P Dow Jones Indices.
The U.S. economy slowed less than initially believed in the first-quarter delivering a 1.2 percent annual growth rate instead of the 0.7% level reported last month, according to the Commerce Department. Although GDP growth in the first-quarter was the worst in a year, U.S. consumer spending recorded its largest boost in four months in April, adding to a rebound in inflation and signaling stronger U.S. confidence. In a separate report launched May 3, the Conference Board said Consumer Confidence declined slightly to 117.9 in May from 119.4 in April. However, consumer confidence is still high and blended with debt ranges that have not seen since the early 1980s, there is likely more reason for optimism regarding future U.S. economic strength. Inflationary pressures remain low, and the latest Federal Reserve Beige Book showed most of the 12 Fed districts reporting moderate economic expansion.
A less-than-expected 138,000 new jobs were created last month and new job creation for the prior two months was revised lower. Companies may be worried that high unit labor costs could affect profit margins, and thus are reducing hiring plans. Unemployment continued to fall, reaching 4.3% last month. Average hourly earnings remained subdued, gaining 2.5% year-over-year. Yet to date, falling unemployment appears to be luring sidelined employees back into the labor force and has recently resulted in relatively low-wage pressure, according to the Bureau of Labor Statistics.
Eventually, this pattern should modify as businesses competition for less employees. The Conference Board’s survey also recorded the strongest reading since 2001 regarding respondent’s perception of the ease of finding a career – both developments should commence driving wages higher.
The strength of various economic indicators will be employed by the Federal Reserve to determine the next rake hike, after a brief pause to be sure the financial weakness in Q1 was temporary. Most expect the 2nd short term interest rate hike this year at the Fed’s next plan meeting in June, and then likely still another increase in September. Still, the Fed projections continue to expect the U.S. to continue its slow and steady pace in hiking rates, which is less aggressive than previous cycles with similar unemployment levels.
The Global Purchasers Administrators Index (GPAI) recorded constant gains through the duration of 2017 and continues to show signs of improvement. The overwhelming bulk of countries are experiencing an acceleration in (GPAI) with exceptions of Greece and scandal-ridden Brazil. However, while the International Monetary Fund (IMF) has projected economic growth of -3.3% for Brazil in 2016, it expects a 0.5% growth rate in 2017, predicting Brazil will come out its recession this year.
Europe is also experiencing continued strong credit demand. After the plunge in demand in 2008 – 2009, 2011 and still another dip in 2013, growth has now been robust since 2015, providing good reasons to feel the recovery can not only last, but pick up speed.
President Trump’s recent visit generated a fair amount of concern over disagreements between the countries. Yet, from an economic perspective, the news has been inconsequential. While Europe may complain that the U.S. backed out of the Paris Accord, the U.S. is the only signing country that’s honored its commitments, mainly because of the U.S.’ market-driven rapid switch to natural gas from coal. However, more encouragingly, issues regarding trade friction have been completely absent.
Germany’s economy proceeds to ramp up, which bodes well for the continent given their historic role as the region’ economic engine. Germany’s historic manufacturing and economic strength combined with the weakening Euro has added to Germany’s trade surplus with the U.S., which happens to be far larger than China’s. The German surplus is also more consequential for America’s economy. While reduced wages in China influence U.S. workers to varying degrees, most of their labor is unskilled. By distinction, Germany’s industries and exports are significantly similar to the U.S. and workers between the two countries are more natural competitors.
The lack of interest to several key issues – protectionism, balance of trade and currency manipulation – that President Trump had threatened to pursue serves both the U.S. and the global economy’s best interests and avoids costly ramifications from threats or actual policy changes between conflicting countries. European equity markets remain at relatively low valuations, and probably provide traders potential that is intriguing, particularly if the euro continues to recover.
Overall, U.S. corporate earnings and the underlying economy remain sound and well-positioned to extend current long-lived bull-market. While news continues to stay positive, current equity valuations remain in or close to the upper quartile. Good news may continue propelling stocks ever higher, but with high anticipations already-built into U.S. equity prices, investors are likely wise to temper anticipations regarding potential industry strength. Finally, I expect market leadership to shift back to cyclical sectors and value styles. These areas of the market led the way in the second half of 2016, but that trend has stalled in 2017. A slowdown in economic growth has caused investors to instead seek out growth and defensive areas of the market. Economic growth should rebound this year, which should lead investors to bid up cyclical and value sectors.