Following a difficult start to 2016, in which the S&P 500 dropped more than 10% in the first six weeks, the market quickly regained its footing. A more than 20% rally from the February lows allowed the S&P 500 to finish the year with a 12% gain. Small company stocks did even better, with the Russell 2000 gaining 21%.
The prospect of market gains appeared bleak during the first half of the year. Although the market successfully reclaimed the losses from the beginning of the year, many factors contributed to increased volatility, making it difficult for stocks to move higher. Concerns about China’s economy, the surprise “Brexit” vote in the U.K., and uncertainty surrounding the Presidential election created a lot of investor anxiousness.
But by late‐summer the market began to rally, and following the surprising result of the Presidential election, the market staged an impressive end‐of‐year surge which brought the index to a new all‐time high. Most agree that the recent rally is attributable to the election results and renewed optimism by investors and business leaders about the economy going forward.
Now that the election has been decided, investors are carefully following developments to identify which campaign promises will become policy. The most impactful policy proposals, from an economic standpoint, relate to tax reform, deregulation, international trade, and infrastructure spending. As inauguration day approaches, there has been a lot of discussion about these topics. Below is a summary of the opinions expressed by many of the economists and strategists we follow.
- Tax Reform—Although many would like an improvement to individual income tax policy, we think this may take some time. The primary obstacle to a quick reform is the potential cost of a tax cut. According to Tax Policy Center, Trump’s tax plan could add $6T to national debt over next 10 years, and $20T over next 20 years. Congressional budget hawks are unlikely to support policy changes that significantly increase our debt. However, corporate taxes have a much better chance for reform in the near‐term. Corporate taxes account for only 8% of the of the national budget, as compared to 40% for income taxes, making corporate tax reform a much less costly policy initiative.
- Deregulation—During the past decade, strict regulations have been implemented in many key areas, including the banking, energy, and auto industries. There is a good deal of support to soften many of these restrictions, which could help stimulate business activity.
- International Trade—Trump has proposed new restrictive trade policies, such as penalties and tariﬀs on foreign transactions. If enacted, these new trade barriers could be harmful to businesses that export their products and to consumers by raising the costs of imported goods. Due to the potential negative eﬀects on the economy, it may be diﬃcult to garner support to carry out these policies.
- Infrastructure—While there is a need to improve our infrastructure, there isn’t a strategy for how the Federal government would support improvement projects. But even with a clear plan, infrastructure initiatives are unlikely to have an immediate impact, as these projects typically require years of advanced planning.
Optimism about the economy and renewed concerns about the potential for inflation caused interest rates to rise across the board in recent months. The benchmark 10‐year U.S. Treasury yield rose to 2.5% from an all‐time low of 1.4% in July. In addition, the Federal Reserve increased their benchmark interest rate in December for just the second time since the financial crisis. Many expect that rates will continue to rise in 2017 and that the Fed will likely increase their benchmark rate at least two more times this year.
The post‐election surge of optimism adds strength to an economy that has plodded along for the past eight years in a steady trend of moderate‐to‐slow growth. Recent signals point to a late‐year acceleration; unemployment is close to a 10‐year low at 4.7%, and GDP grew at an annualized rate of 3.5%. Forecasts point to continued improvement in 2017, with GDP expected to grow 2‐3%.
Although many consider the market at, or slightly above, fair value, an uptick in corporate earnings could support a new upward trend in the bull market. Corporate tax reform, deregulation, and rising energy prices all have the potential to boost corporate profits. Considering these factors, analysts expect earnings to rise by as much as 20% in 2017. There is also hope that continued optimism and a renewal of the “animal spirits” might motivate investors and business leaders to begin investing more of their available funds in stocks and capital projects.
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