Stocks moved higher during January as investors were heartened by healthy economic data coming out of both the US and Europe. Politics continued to be a focal point for markets at the outset of the Trump presidency. We do have concerns that the new administration’s turbulent start could erode GOP support for some of Trump’s market friendly proposals. However, we continue to believe that some combination of fiscal stimulus, tax reduction, and regulatory reform will most likely move forward, benefitting the economy as well as corporate profits.
Economic data released during January were quite healthy in our view. Auto sales capped off a strong year with a December selling pace of 18.4 million vehicles, the best monthly showing since July 2005. While car manufacturers offered significant sales incentives, the auto market was also likely a beneficiary of improving labor market conditions. In this regard, we note that the US economy added 227,000 jobs in January, easily surpassing consensus expectations for 180,000 additions. Moreover, ADP noted in its National Employment Report for January that “the US labor market is hitting on all cylinders”. Perhaps it is not surprising in the context of a tighter labor market that consumer spirits are rising as well, as evidenced by the University of Michigan’s latest reading of consumer sentiment which rose to levels not seen in over a decade.
We are also seeing signs of optimism in the corporate sector, as illustrated by recent purchasing manager surveys. For example, The Institute for Supply Management’s survey results of the manufacturing sector recently hit its strongest level in two years. As well, we have an optimistic early take on Q4 earnings season. With 175 S&P 500 companies having reported as of this writing, approximately two-thirds have exceeded earnings estimates, and profit growth is averaging just over 9%. Revenues are slightly outpacing estimates thus far, coming in at an aggregate 3.2% year-over-year growth rate.
Europe’s economy has also shown signs of strength. Markit’s December purchasing managers’ index for the Eurozone’s manufacturing sector came in at 54.9, the best reading since April 2011. Labor market conditions also continued to improve as the unemployment rate reached a seven year low (9.6%) in December. European sovereign bond yields have also been moving higher, in our view a reflection of these improved economic conditions alongside a pickup in inflationary expectations. The German 10-year government bond recently yielded 0.49%, the highest level in a year. French and Italian government bond yields are also approaching highs for recent years.
We continue to hold a cautiously optimistic outlook on the market. As noted, the US economy appears relatively healthy, and we have reasons to expect this to continue. One metric that we closely track is the number of domestic oil and gas drilling rigs in operation, which has been moving steadily higher of late. The current count stands at 729, up from 404 just nine months ago. This is an important barometer, as operating rigs drive meaningful amounts of economic activity. We are also optimistic that corporate earnings can continue to move higher. During the third quarter profit growth turned positive following five consecutive quarters of declines, and the positive momentum may be accelerating in the fourth quarter. Finally, we continue to believe that Trump’s objectives pertaining to tax and regulatory reform, as well as infrastructure stimulus, can further boost economic activity, and that passage remains likely as long as the administration’s relationship with the GOP does not erode further.
A key risk to the market in our view is the potential for political tensions to derail Trump’s pro-growth objectives. At current levels, we believe that markets are reflecting at least a certain degree of economic boost from these agenda items, and therefore stocks could be at risk if they do not come to fruition. We are also keeping a close watch on inflation, which has been moving higher. Consumer prices advanced 2.1% in December, the largest increase in two years. Higher inflation could force the Fed to tighten interest rates at a faster pace than it currently envisions, which in turn could dampen economic growth. Higher rates of inflation are also typically correlated with contracting price-to-earnings ratios, another key headwind for stocks. At the moment, however, our view is that despite the recent pick-up inflation remains at benign levels. As always, we remain committed to seeking long-term growth through our risk-conscious investment approach.
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