After a strong post-election rally that pushed the S&P 500 to a 9.5% gain for 2016, we are asking ourselves; what can we expect of the markets in 2017?
The post-election market action has been widely described as a “Trump Rally,” and while there is certainly some validity to the argument that the new administration has excited investors who anticipate increased earnings and higher stock prices with the President’s pro-growth agenda — tax cuts, deregulation and increased infrastructure spend, we are firmly in the camp of those that believe improving economic data points are the main reason the market is supporting higher valuations.
Economic fundamentals have been steadily improving for some time: unemployment below 5%, housing on the upswing, and consumer confidence is strong as wages creep higher (though personal consumption is still weak).
We’ve witnessed a rotation into cyclical names – financials, energy, and industrial stocks – typical of late economic cycle action, and this has proven to be just the needed ingredient to give the market its recent pop. Given, however, that we are in the later stages of the economic cycle and certainly faced with challenging demographic and productivity constraints, near-peak employment and near-peak consumer and business confidence, heightened political expectations, growing concerns about the impact of protectionist policies that are as yet undefined, and with deficits at near record levels, we are proceeding with a cautious posture.
If history is any guide to late cycle investing, there is still money to be made in the markets, but active investing, choosing the right sectors and stocks given elevated valuations, will be as important as ever. Implementation and timing of pro-growth fiscal policies argue for an earnings impact with higher inflation and higher rates likely in 2018 as the economy strains against employment capacity limits, with talk of recession hitting in ’19 a distinct possibility.
We view this period as an opportunity to review asset allocation and consider rebalancing portfolios where appropriate. For those clients seeking yield we remain active in both the taxable and municipal bond markets and continue to find value in high quality issues, preferring to take credit risk to enhance yields rather than interest rate risk. With higher rates on the horizon and broad equity markets hitting record levels, we are closely monitoring developments in the economic and political arenas with an eye on adjusting the investment mix as necessary, while keeping long-term portfolio goals front of mind.