Key Points
• The post-election rally took a break last week as investors await corporate earnings news.
• We believe global economic growth will accelerate, providing tailwinds for equities and other risk assets.
• 2017 is likely to be a stock-pickers market, as we expect further diversion between individual securities.
Equity markets were mixed last week, with the S&P 500 Index down fractionally.1 Investors grew more wary about President-elect Trump’s increasing scrutiny of specific corporate policies and a possible push for higher tariffs. The health care sector suffered due to drug pricing concerns, while retail sectors were hurt by generally disappointing earnings results.
Forward Guidance Is Key for Earnings and Equity Prices
As the fourth quarter earnings season begins, we think earnings are improving, but we expect mixed results. We believe interest rates, the U.S. dollar, oil prices and wage rates will drive results over the course of 2017. For the current reporting quarter, we expect higher oil prices will benefit energy and related sectors, and think the stronger dollar will present a headwind for larger multinationals.
Furthermore, we are closely watching forward guidance. Investors will scrutinize earnings statements for hints about what corporate management teams expect in terms of possible tax reform, regulatory changes and economic growth. These factors are likely to drive capital spending, hiring plans and a range of other corporate actions that could affect equity prices.
Overall, both consumer and business confidence appears high, and corporate earnings and economic growth should accelerate in 2017. This should produce tailwinds for stock prices, but gains are likely to be uneven and more company-specific compared to recent years.
Weekly Top Themes
1. Rising wage inflation brings positives and negatives. Rising wages are good news for consumer spending, but they may drag down corporate profitability.
2. We expect action on the “Trump Agenda,” but with little economic impact until 2018. We expect the new president and Congress to aggressively move on tax reform and fiscal stimulus. Such legislation is complex and it will take time to take effect, so any results won’t be felt until next year. Investors are hoping that fiscal stimulus will offset tighter monetary policy, allowing growth to accelerate. The risks are that the economy slows before fiscal stimulus can take effect or decreasing liquidity becomes a problem for financial markets.
3. Correlation between individual stocks is falling, possibly presenting opportunities for active managers. According to Bernstein Research, the post-election environment produced the period of the lowest correlation between individual U.S. stocks since the height of the financial crisis (meaning the performance of any one stock was less affected by moves in the overall market). We expect this low-correlation environment to persist, which should make security selection and careful research critical to investment success.
Global Growth Should Improve, Helping Risk Assets
Investors remain highly attuned to potential changes in the political backdrop. Since the election, expectations for more pro-growth policies in 2017 have caused increases in equity prices, bond yields and the U.S. dollar. Sharply rising yields and a stronger dollar could present risks for stock prices, but bond yields and the dollar have retreated slightly in recent weeks. These moves probably reflect fading concerns over a faster-than-expected rate hike campaign by the Federal Reserve. The minutes from the Fed’s December meeting show that policymakers expect growth and inflation to rise, but not at a pace requiring significant or rapid monetary tightening.