Quarterly Investment Outlook: March 2017

SUMMARY

• We continue to expect a grinding cyclical recovery with an upward bias to bonds yields.  However in the near term:  equity markets are extended, momentum is rolling over, and sentiment is elevated, pointing to a period of consolidation/correction.  Bond yields are correcting their 4Q16 advance and could test 2%, at which point we intend to move to below average duration.

• The slowing growth in non-farm hours worked, lack of upward momentum in non-defense capital goods orders, and the elevated level of Economic Surprise Index makes us skeptical of analysts' earnings forecast of 10% growth in 2017.

• Monetary policy is set to tighten over the next two years.  The forward 12 months  p/e ratio at 18x is at a decade high.  Eroding margins and rising interest rates will limit further multiple expansion.

• CBO budget projections forecast that deficits/debt should trend higher over the next ten years, reflecting increases in both health and retirement benefits.  This assumes modest growth and no recession, which most analysts, including ourselves, believe is far too optimistic.  As of this writing there is little clarity regarding Trump's fiscal plans, including the extent to which they will be deficit neutral.  In the end, tax relief and infrastructure spending are pro-growth.  However they could be largely offset by a border tax and/or targeted tariffs.  Tariffs can be implemented by executive order and would represent a potential roadblock to our cyclical recovery thesis, and a continuing bull market in risk assets.

• The equity market is fully valued as shown in our proprietary earnings and dividend discount model.

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