Weekly Markets Commentary — January 3, 2017
David Joy – Chief Market Strategist, Ameriprise Financial
The Reality of a New Administration Becomes Top of Mind for Investors
In the five weeks immediately following the U.S. presidential election, the S&P 500 rose 6.1 percent, as investors adjusted to the perceived implications of a Trump victory. Financials, industrials, energy and materials stocks were noted beneficiaries. Defensive groups lagged behind. But the rally stalled into year-end. Over the final two weeks, the S&P slipped by 1.5 percent, as the initial sector winners and losers traded places. So, what happened? There were likely several factors at work.
It is probably no coincidence that stocks peaked on Dec. 13, the day before the Federal Reserve raised interest rates for the second time in this cycle and, more importantly, signaled its expectation of three more rate increases this year. Investors were clearly taken by surprise and began to rethink what higher rates might mean for economic growth, corporate profits and valuation multiples. The yield on the ten-year note surged from 1.86 percent on Election Day to 2.60 percent on Dec. 15. Since then, however, the yield has fallen back to 2.44 percent and the spread between the two and ten-year maturities, critical to profitable lending, narrowed somewhat into year-end after having widened sharply after the election, and the surging dollar plateaued. Not surprisingly, the rally in financials promptly stalled.
Another factor at work was the growing sense that the rally may have run ahead of itself. Since the election took many by surprise, a sudden repositioning should not be unexpected. But the anticipation of a very different investing environment ahead, whether in terms of faster growth, less regulation or tax reform, is not the same as its realization. And even if policy in the new administration is more investor-friendly, how much of that was already reflected in the rally remained an open question. So, some sober reconsideration was understandable.
And, no doubt, investors were beginning to look ahead to the approaching reality of the new administration actually taking the reins of government, and wondering what that might mean in practical terms. Now that the New Year is here (and the inauguration is less than three weeks away) we are about to get a good sense of how Congress will function, especially the Democratic opposition. Confirmation hearings for the first two of Trump’s cabinet nominees, Sen. Jeff Sessions as Attorney General and Rex Tillerson as Secretary of State, are scheduled for next week. And, as the Washington Post reports, Democrats have no intention of following tradition and expediting the confirmation process, hoping instead to delay it well into March, preventing the new administration from hitting the ground running.
Consumer Confidence Continues to Climb
Throughout this time consumer confidence has continued to rise. Last week the Conference Board reported that its index of consumer confidence rose in December to its highest level in twelve years. And there is a positive correlation between consumer confidence and spending. But the recent rise also means that confidence is currently higher than just before the onset of the financial crisis, and at its highest level since the dot com boom. At the current level of 114, the index is still nowhere near the peak levels of euphoria from 2000 when the index hit 143. But that episode aside, it is approaching 120, a level that has represented a ceiling in the past.
The consumer sentiment index maintained by the University of Michigan is exhibiting a similar pattern. It also rose to a twelve year high in December, and the tech stock bubble aside, is approaching its previous highs near 100. Business confidence has also risen recently, but only modestly, especially when it comes to plans for capital investments, which remain quite subdued.
Fundamentals will attempt to force their way back into investor consciousness this week. The December employment report will top the list, and is expected to show that the labor market retained its momentum. A total of 178,000 new non-farm jobs are anticipated, according to Bloomberg, matching November’s total and in-line with the average job growth of the past three months. Average hourly wages are forecast to rise to 2.8 percent, matching its October high, which itself was the highest since June, 2009. Also on this week’s economic calendar are the ISM manufacturing activity reports, vehicle sales and factory orders. And looking ahead to next week, fourth quarter earnings season gets underway. Factset now anticipates earnings growth of 3.2 percent in the quarter, and 0.2 percent for the full year. For 2017, earnings are expected to rise 11.5 percent.
Futures are pointing to a higher opening on Tuesday, and the yield on the ten-year note is once again back above 2.50 percent, reopening its spread to the two-year. If investors are once again feeling optimistic, the two week downturn to end the year will have been the aberration, at least for now.