Weekly Markets Commentary — January 23, 2016

David Joy – Chief Market Strategist, Ameriprise Financial

Investors Keeping an Eye on Wall Street and Washington

The Trump presidency has officially begun. Following his inaugural address it seems clear that the new president intends to focus on the same issues he championed on the campaign trail. What remains unclear is how accommodating the Washington policy apparatus will be toward his stated goals and his governing style. Investors are conflicted. They are both counting on favorable enactment of reforms in the areas of taxation and deregulation, but also anxious that the president’s views on trade and foreign relations may prove disruptive.

After the initial run higher following the election, stocks have drifted sideways since mid-December. No doubt some of that pause is attributable to profit taking, as investors follow through on the theme of buy the election, sell the inauguration. Part of it is likely due to a reluctance to commit further until there are some tangible policy successes, or at least some further clarity on the details of his policy initiatives. But some of the pause is also likely due to concern that the president’s views may result in strained foreign relations, especially among our major trading partners, but also among our allies and enemies alike.

This ambivalence is expressing itself in a market that is drifting, hoping for the best, but fearing the worst. In the latest weekly survey of the American Association of Individual Investors, the percentage of respondents identifying themselves as bullish fell 6.6 percent to 37.0, while those self-identifying as bears rose 5.7 to 32.7 percent. This reversal continues the trend that began in late November. After a surge immediately following the election that saw bullish sentiment rise from a modestly low reading of 23.6 to a peak at 49.9 percent on Nov. 23, the survey has since steadily declined.

The survey is often viewed as a contrarian indicator, and sentiment did indeed prove to be too bearish prior to the election, setting the stage for the subsequent rally. But the sharp rise in bullish sentiment following the election may itself have been excessive. The survey’s current readings are within the range of normal distribution, which may be consistent with the sideways move in the market over the past five weeks, and suggest a sense of caution while investors watch and wait.

Market Sentiment and the Economy Remain Steady

Other market- based measures of sentiment also reflect a sideways drift, albeit with stocks still trading near their recent highs. The percentage of stocks in the S&P 500 trading above their intermediate and longer-term moving averages has remained relatively steady, declining only slightly since mid-December. And overall market breadth remains in a modest uptrend, which itself has moderated since mid-December after a sharp post-election rise. As stocks have drifted, gold has been among the beneficiaries, as the perceived safe haven has climbed more than 7.0 percent since mid-December. Over the same time period, the dollar has slumped.

Fortunately for the new administration, the U. S. economy is showing no such ambivalence. The latest round of data shows steady growth. Housing starts rebounded in December after declining sharply in November. Weekly jobless claims fell close to their lowest in four decades, echoing the labor market gains referenced in the Fed’s Beige Book report. Consumer prices firmed to 2.1 percent year-over-year, its highest reading since June, 2014. These reports follow other recent reports evidencing strength in job creation, retail sales, small business and consumer confidence.

Last week’s data from China showed slightly better than expected economic growth and retail sales, and only a small decline in industrial production and investment. The Eurozone is also showing strength in industrial production, modest growth in retail sales, steady inflation and rising confidence survey readings. And last week the European Central Bank (ECB) reiterated its commitment to its accommodative monetary policy. In its just released January update to its October World Economic Outlook, the International Monetary Fund (IMF) raised its forecast for 2017 economic growth in the U.S., Japan, Germany and the UK. Cumulatively, the advanced economies of the world are now expected to grow by 1.9 percent in 2017, an increase of 0.1.

Emerging economies are now expected to grow by 4.5 percent this year, a 0.1 percent reduction from October’s forecast, on lowered expectations for India and Brazil. China, in contrast, saw its growth forecast for 2017 revised slightly higher, to 6.5 percent, or 0.3 percent higher than in October. Overall, the global economy is forecast to grow by 3.4 percent in 2017, unchanged from the October forecast.

Investors Watch for Positive Corporate Earnings

Fourth quarter earnings season ramped up last week, and the early focus on financials has set a favorable tone. According to Factset, through last Thursday 12 percent of the S&P 500 has reported so far, and the projected rise in fourth quarter earnings is now 3.4 percent, up from 3.0 percent at the start of the quarter. Among the companies reporting this week are Halliburton, McDonald’s, 3M, Alcoa, Dupont, Dow, Johnson & Johnson, Verizon, AT&T, Boeing, eBay, Alibaba, Alphabet, Baker Hughes, Bristol-Myers Squibb, Caterpillar, Ford, Intel, Microsoft and Chevron.

We will also get the advance estimate of fourth quarter GDP this week. The Bloomberg consensus anticipates growth of 2.2 percent, following the 3.5 percent pace of the third quarter. Also on the economic calendar this week are new and existing home sales, flash manufacturing PMIs, leading indicators and durable goods orders.

Investors will have to divide their focus this week between Wall Street and Washington, as the new administration has indicated that this first week could be a busy one in terms of executive actions. We have not seen a meaningful move higher in expected volatility in the last few weeks, as some have anticipated. That may be about to change.