21 Nov 2016
The U.S. Presidential election is over but uncertainties remain
The U.S. Presidential election is complete and despite the surprising result, stocks have staged an impressive rally. The country has managed to move on following bitter election fights and continue to prosper to varying degrees, and we have little doubt that will occur this time around, too. As such, we urge investors not to overreact to the results and to remain focused on long-term goals.
Investor sentiment leading up to the election had slumped as polls tightened, which set the stage for a rebound as some of the money that was moved to the sidelines in the run up to the election quickly moved back into stocks. But just because the U.S. election is over, it doesn’t mean volatility is likely to ease. The priority of President-elect Trump’s policy proposals are being weighed; and although the election was a Republican sweep, they still don’t have 60 votes in the Senate, other countries have important elections coming up, Fed policy uncertainty persists, and foreign central banks have begun to back away from negative interest rates.
Economic expansion continues—at a modest pace
Despite all the hand wringing over the election, the U.S. economy continues to grow, with third quarter gross domestic product (GDP) growth accelerating to 2.9% on an annualized basis, up from 1.4% in the second quarter, according to the Bureau of Economic Analysis. Part of the acceleration was due to inventories rebuilding after falling in the previous quarter; while the reading also got a boost from a surge in soybean exports due to crops in Brazil and Argentina being hit by weather issues (Reuters). As such, those boosts are unlikely to be repeated; but the early fourth quarter data suggest that we won’t give back all of the gains seen from the previous quarter. For example, auto sales rebounded after concerns that they may be in for a longer slump.
Additionally, the Institute for Supply Management’s (ISM) Manufacturing Index moved further into territory depicting expansion by posting a 51.9 reading, up from 51.5. The ISM Non-Manufacturing Index also posted a solid reading, despite a modest pullback from the jump seen the previous month, moving to 54.8 from 57.1.
We are also hopeful that some political certainty could finally move companies to expand their capital expenditures which could be aided by promised regulatory relief, corporate tax reform, a plan to bring back cash held overseas, or a combination thereof. As seen below, capital expenditures have typically tracked with the operating rate, which remains somewhat depressed. It’s a bit of a chicken-or-egg scenario—companies won’t extend capex until their current resources are used to capacity, but they likely won’t be used at capacity until companies increase investment.
The fact that oil prices have stabilized and rig counts have started to rise should have a positive impact on spending in the energy space, which was slashed following the meltdown in prices. However it is unlikely we’ll see a big recovery in spending as caution in the space remains high judging from comments from major oil companies during earnings season.
Housing has been a positive force in the U.S. economy recently, and the increase in household formations should continue to support both the economy and consumer confidence. Consumers should also be bolstered by continued healthy employment conditions. Another 161,000 jobs were added to non-farm payrolls in October, while the unemployment rate dropped to 4.9% and average hourly earnings (AHE) increased again to 2.8% growth year over year. Other wage data measures—some adjusting for the mix-shift problems inherent in AHE—show an even sharper increase.
Fed picture becoming clearer but….
“Full” employment is at least in sight, housing is recovering, economic growth has improved and inflation is heating up. As such, the Fed funds futures markets are pointing to a rate hike at the Fed’s final meeting of the year in December. That may remove some uncertainty, but questions will remain as to the path and frequency of rate hikes in 2017 and beyond. We continue to believe the Fed will be able to go slow in normalizing rates, as they have stated they want to do, but signs of rising inflation could force its hand. Of note, commodity prices have shown signs of stabilizing, wages are rising, and the core Consumer Price Index (CPI ex food and energy) has moved to 2.2% on a year-over-year basis.
At this point, we don’t see inflation taking off or causing the Fed to aggressively hike rates, but there is a risk the Fed could be seen as getting “behind the curve” if inflation heats up. We’ve already seen a significant increase in Treasury yields. Much attention pre- and post-election has been on Fed chair Janet Yellen and whether her post is in jeopardy. A president is limited in his ability to remove a sitting Fed chair, but it does bring up the possibility that she may not remain beyond the end of her term in 2018.
The election is over but some uncertainty remains, which means bouts of volatility are likely to persist. The Fed is likely to hike rates in December but uncertainty about the path of rates in 2017 will persist.
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.