13 Feb 2017
Continuation of the bull market in U.S. stocks is expected
The stunning election ushered in a remarkable rally in stocks, but also, the U.S. dollar and Treasury yields. By mid-December, these rallies took a breather; with stocks moving sideways, and yields and the dollar pulling back. As earnings season began, and the Trump administration took office, stocks resumed their move higher, recently culminating in the Dow breaking through the psychologically-meaningful 20k mark. Investor sentiment has been mixed with the Ned Davis Research (NDR) Crowd Sentiment Poll remaining in extremely optimistic territory; but the more volatile Daily Sentiment Poll moving lower. In addition, the American Association of Individual Investors (AAII) survey also shows bullishness faded quickly during the market’s consolidation phase, indicating that sentiment remains skittish—a characteristic of this bull market which remains healthy. Additionally, the modest reversal in yields has eased concern that rapidly rising rates would signal higher inflation and crimp economic output, appears to have diminished.
Investors continue to try to get a handle on the new world order, with the Trump administration making a flurry of moves in the early days, and Federal Reserve officials behaving more hawkishly. We caution investors to remain disciplined as today's extremely low volatility, as measured by the VIX, is unlikely to persist without periods of choppier market action. We reiterate our view that U.S. stocks will outperform developed international stocks in the coming months and believe investors who are under-exposed to U.S. stocks use any volatility to rebalance positions as needed.
Economic data continues to surprise on the upside
We believe the market's post-election gains were not solely related to optimism about the pro-business leanings of the new administration. The gains have also reflected improving economic data (which troughed in October) and better corporate earnings (which troughed in the first half of 2016). The National Retail Federation reported that holiday spending was up a solid 4% over last year; although the mix is certainly changing as department store sales actually fell 7%, while non-store retailers (online) rose 12.6%. This reflects the recent improvement in consumer confidence as well as the continued healthy job market, illustrated by the continued low level of initial jobless claims, and stronger wage growth.
Corporate confidence has surged as well. As recently highlighted in this publication the National Federal of Independent Business (NFIB) noted a record-breaking increase in optimism among small business owners. That optimism was supported by an increase in industrial production in December of 0.8% and a rise in capacity utilization to 75.5 from 74.9, according to the Federal Reserve. Additionally, regional manufacturing surveys have shown nice increases—including the Philly Fed Manufacturing Index, which rose to a robust 23.6 from 19.7. And although the fourth quarter 2016 earnings reporting season is ongoing, the results look fairly positive, with many financial companies beating estimates and issuing more optimistic outlooks. According to Yardeni Research, forward earnings estimates continue to rise, and don't yet reflect the possible additional upside associated with proposed fiscal stimulus. The rub of course is that the expectations bar has been set higher, which sets up the risk that the actual results underperform those loftier expectations.
Inflation ticking higher, while Trump era begins
Inflation pressures are building and it's a phenomenon with which investors haven't had to deal in over a decade. As noted, wages are moving higher, and the recent Consumer Price Index (CPI) showed prices at the core level (ex-food and energy) rose 2.2% year-over-year, which is above the Fed’s target of 2%. "Fedspeak" has become slightly more hawkish recently; including from Fed Chair Janet Yellen, who noted that she expects the Fed to raise rates "a few times a year" through 2019. We do believe a hike at the March meeting is on the table.
Now that it's President Trump instead of candidate or President-elect Trump, we'll see how quickly some of the much talked about plans come to fruition. Issuing executive orders to roll back previous executive orders is relatively easy in a lot of cases; but getting tax reform and new health care legislation written and passed will prove to be more difficult. In addition, those who had hoped protectionism would take a back seat to more growth-friendly proposals have faced President Trump acting as aggressively as did candidate Trump. Investor and corporate confidence may have gotten a bit ahead of the pace at which many of the administration’s policy priorities can get enacted, and the balance between those which are growth-friendly and those which could retard growth and confidence.
The world is changing for investors but we believe it's largely in a positive way, although there will be bumps along the way. The recent sideways equity movement was a healthy consolidation of the post-election gains, and we suggest investors add to U.S. equity positions as needed at the expense of some developed market international exposure. Inflation is ticking higher, and the Fed is becoming more hawkish, but the conditions supporting those moves are also positive supports for stock.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.