Markets took their cues from the U.S. presidential election during the fourth quarter. Likely surprised by the outcome, investors added to cyclical holdings while paring back on income-oriented securities. While some stocks may have gotten ahead of themselves, in aggregate we believe the market can still move higher, driven by the incoming administration’s aims to boost growth via corporate tax cuts and regulatory reforms.
Stocks have continued to appreciate in the aftermath of the U.S. presidential election, presumably as investors reposition themselves for the incoming Trump administration. In our view, the most significant of Trump’s economic proposals are corporate tax reduction and the easing of regulatory burdens. We continue to believe that both of these agenda items can meaningfully impact growth throughout the economy. The former could provide an immediate lift to corporate profits, while the latter could likely boost both revenues and margins for many companies. Moreover, we also expect that among Trump’s various proposals, these two carry a reasonably strong likelihood of passage through Congress without being overly diluted.
Bond yields had been moving higher even before the election, but the trend strengthened considerably following Trump’s surprise victory, as investors began to anticipate stepped-up fiscal spending and other pro-growth initiatives. As a result, the 10 year U.S. Treasury yield hit a recent high of 2.6%, nearly doubling in just five months. While this certainly qualifies as a big move in the fixed income world, we are not overly concerned that higher interest rates will derail the stock market. This is in part because of the historically low starting point for yields, and also because we view much of the increase as being indicative of an improving economic outlook. Additionally, in our view, the magnitude of yield appreciation is unlikely to be sustainable. While it is not difficult to envision higher yields moving forward, particularly given that they remain below historical averages, we are hard pressed to envision a near-term scenario in which they move sharply higher from current levels.
Turning to monetary policy, both the Federal Reserve and European Central Bank held meetings in recent weeks. As was widely expected, the Fed raised its benchmark interest rate target by 25 basis points to a range of 0.50%-0.75%. Less expected was the increase in the Fed’s projection for interest rates for 2017, which now implicitly calls for three hikes compared with a prior forecast of two. Some investors may be getting anxious that a faster than expected pace of interest rate increases could roil stocks. We view this as unlikely, however, because the Fed has consistently overestimated its interest rate forecasts in recent years. Moreover, similar to the recent move in yields, we view this new slightly more aggressive forecast as a positive sign, as it indicates that the Fed is increasingly confident in the health of the economy.
In Europe, the ECB made news with its announcement that it would slow the pace of its monthly asset purchases from €80 to €60 billion beginning in April 2017. We have noted in recent months that central banks are starting to inch away from the extremely dovish policies which have persisted in recent years. We take this reduction in asset purchases as well as the Federal Reserve’s December rate hike as further confirmation of this shift. Once again, while it may seem reasonable to view these dynamics as negative for stocks in that monetary support is being lessened, we view rate increases constructively as policy makers would not be taking these steps if central bankers were not increasingly confident in their respective economies.
We continue to hold a guardedly optimistic view on the market. We remain positive on the consumer, a key cog of the U.S. economy. Wages are moving higher as unemployment continues its downward trend. Perhaps as a result, widely followed measures of consumer confidence from both the Conference Board as well the University of Michigan came in at healthy levels, which in our view bodes well for retailers. As discussed, we believe that President-elect Trump’s proposals to reduce taxes and regulatory burdens should give a lift to corporate earnings, which in turn should help to support stock prices.
We do, however, see risks to the market which keep us from taking an overly bullish stance. While we see much to like about Trump’s pro-growth proposals, we are wary of positions on immigration and trade that could weigh on economic growth. We also wonder how difficult the cabinet approval process will be, and our concern here is whether too much political capital will be expended that otherwise could have gone towards the passage of fiscal stimulus, tax reduction, and deregulation initiatives. The rising dollar is another concern, one measure of which recently hit a 14-year high. Should the dollar continue to strengthen, both corporate profits and exports could be impacted negatively. Finally, we note that the bull market has been in place for eight years now, significantly longer than the average length of historical precedents. This extended run, along with above-average market valuations and elevated levels of political risk are enough to temper our otherwise positive outlook on the market. It’s important to keep in mind that periods of uncertainty, such as a new incoming administration, usually create opportunities as well as traps. We will continue to assess the evolving investment landscape as we seek opportunities for long-term growth.
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.