Quarterly Investment Outlook: January 2017
/SUMMARY
• The essence of Trumponomics appears to be 1) a tougher stance on immigration, 2) to renegotiate existing trade agreements if possible, 3) implementation of tariffs on Mexico/China ranging from 35% - 45%, 4) to reduce marginal personal tax rates from 39.6% to 33%, while simplifying the income tax bracket from seven to three, 5) to reduce corporate rates from 35% to 15%, 6) an increase in infrastructure and military spending, 7) to curb regulation.
• Since 2009 real GDP has averaged 2.1% CAGR. Measured on a yoy basis, the gain for 2016 is a meager 1.7%. The Federal Bank of Atlanta GDP tracker is currently forecasting Q4 growth of 2.4%, bolstered by rising consumption, residential investment and equipment purchases. The outlook for increased fiscal stimulus, noted above, could result in GDP growth of 3% in 2017.
• Business confidence feeds off of the consumer. In this regard it is encouraging that the Michigan Consumer Sentiment, a measure of consumer confidence, came in at 93.8 for November, up from a forecasted reading of 91.6. This is a positive development as the initial reaction of the consumer to Trump's victory was to express optimism about their personal finances and improved prospects for the economy.
• The reaction to Trump's election was immediate and was expressed in higher stock prices, rising treasury yields, and a stronger U.S. dollar. The S&P 500 at 2213 now trades 5.2% above its 200day moving average, which indicates an overbought market. We are concerned that the advance has been narrow, with the NYSE Advance/Decline Line, a measure of market breadth, failing to confirm the recent new highs in the S&P 500. In addition, our valuation analysis shows the market has already largely discounted expected earnings growth of 9% for 2017.
• Dollar strength is pressuring corporate earnings, which just recorded their first positive yoy gain in seven quarters. Margins are under pressure from rising unit labor costs and nominal revenue growth. Rising interest costs will also pressure forward earnings with corporate leverage having risen in the past several years, due to companies buying back shares. Domestic companies are in the best position to benefit, especially those with pricing power. Oil and gas shale producers are our favorite industry choice.
• In order to move from a defensive to cyclically biased strategy, we need to see more evidence of 1) real fiscal stimulus, 2) clear signs of a recovery in global growth, 3) a pause or reversal in the dollar's advance, with strength in EM currencies, 4) a steepening in the yield curve, 5) continuing advance in the stock/bond ratio. Preliminary signs point to increasing economic momentum in both China and the U.S., which are major drivers of global growth.
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