“Life is really simple, but we insist on making it complicated.”
Via Rafael Matsunaga
Markets continue to move up despite a slowdown of momentum for the Trump Agenda. The economy is on a pace to grow above the 2% level in the second half of 2017. A chorus of permabears; David Rosenberg, Marc Faber, David Stockman and recently joined again by Nouriel Roubini, are all in sync in saying that markets are “doomed.”
Reasons may vary, but the conclusion is unanimous. Most often-heard for a correction is the extended length of the current bull market. Presently, the 2009-2017 bull market is the second longest in history, and third in appreciation. Since the election, the S&P 500 has gained 14.1% while the NASDAQ has risen 17.2%, both indices are near all-time highs. Since the bottom on March 9, 2009, the S&P 500 has gained 257% but has remained one of the least respected bull markets in history. Contrary to what many pundits predict at every selloff, stocks do not collapse from age. In fact, the recent move in equities since the election is more reminiscent of 2013, when stocks measured by the S&P 500, gained over 30%. Without any help from fiscal stimulus, full year 2017 earnings are forecast to increase 10%, but these estimates continue to be revised higher, unlike during the past three years. For 2013, earnings grew an actual 6%, followed by 8% in 2014. Both 2012 and 2016 had corrections early in the year. In 2012, it was the European Sovereign Debt crisis and for 2016 it was oil, China and the US dollar.
The problems which led to the selloffs over the past few years have lessened or disappeared. Europe remains in reflation mode and Brexit, although set to reappear March 29, is confined to the UK and the EU – fallout to US interests is minimal. Oil, which in early 2016 approached $26 a barrel, has since doubled and hovers around a manageable $50 a barrel. Even with cheating on output quotas, there is little chance of a retest of the lows of February 2016. For years, China was widely believed to be incapable of transitioning to a consumer economy. Aside from avoiding the expected financial shock, it is now on a path to managing the debt cycle and longer-term the emergence of a high income economy. The US dollar stabilized in 2016 and remains high, but below the peak levels of 2015. The US Dollar Index (DX) is 8.8% above the May 20, 2016 cyclical low.
There is little doubt that the election tipped the scales to growth. The current Administration’s ability to rapidly enact its fiscal stimulus has been stalled by politics. Firstly, Repeal and Replace Obamacare was a bad choice as the initial policy initiative. There is no economic value to Trumpcare, only fulfillment of years of GOP rhetoric on a better plan, which thus far is unsubstantiated. A replacement is 2-3 years away, and will be contentious and headline grabbing at every turn. Secondly, the cost estimates of replacement going forward from the Congressional Budget Office (CBO) will negatively affect tax reform. With a sizable conservative contingent, i.e. the Freedom Caucus, the passage of any budget busters is unlikely. Demands for a “revenue neutral” tax bill will be center stage with higher health costs limiting the savings to individuals and corporations. For the time being, it will be the rollback of Obama-initiated regulations that will stimulate additional growth.
Wall Street has not reacted to the first Trump Budget, knowing full-well it will not be passed as presented. Congress holds the purse strings, and for elected officials, the proposed budget is extreme. Defense will not get an additional $50 billion, nor will the cuts be as deep. Where infrastructure spending winds up is anyone’s guess. Throughout all these negotiations, there will be a unified Democratic opposition, whose primary purpose is disruption and delay. For now, the economy and earnings will have to carry the stock market. Consumer and business sentiment currently remain optimistic and the prospect of additional reduced financial regulation is on the horizon. Already, banks are broadening their loans and the removal of environmental restrictions have moved stalled energy projects forward. Eventually it will be Tax Reform and the Repatriation of overseas funds that extend and broaden the current bull market.
Our investment policy remains optimistic. There is no justification for a bear market. Most bear markets occur in conjunction with a business cycle downturn, resulting in a recession. Today that possibility is nonexistent. We do not discount a market selloff as investors become frustrated with slow implementation of stimulative policies. However, any correction should be considered a long-term buying opportunity. It is unlikely that the broadening strength in the economy and the outlook for corporate earnings that the long-term bull market will be interrupted. Realistically the positives from expansionary fiscal policies will take more time than generally expected. Longer term we believe that consumer-led economic growth, accompanied by slow rising real interest rates and moderate inflation, will result in increased earnings and multiple expansion with further upside for select domestic Large-Cap consumer, financial, industrial and technology companies. Technology is the sector that should benefit most. We favor companies across all sectors that combine consumer demand with innovation. Additionally, with full employment approaching, technology investment is needed to achieve productivity gains. To mitigate the potential of higher-than-expected inflation and multiple compression, portfolios should include value companies exhibiting sustainable earnings growth and dividends.
Written by David Minor & Rebecca Goyette