Key Points
-Equity prices rose again last week primarily in light of solid corporate earnings and the French election results.
-Political optimism over the prospects of progrowth policies in the United States is fading.
-We expect economic and earnings growth to improve, which should provide a tailwind for equity prices.
Investors responded to a mountain of economic, political and earnings news last week. First quarter corporate earnings continued to look strong, while the first quarter gross domestic product report was disappointing. Markets reacted positively to the first round of voting in the French presidential election and began digesting President Trump’s tax blueprint. Overall, investor sentiment improved, with the S&P 500 Index rising 1.5%.1
Weekly Top Themes
1. Despite a slow first quarter, consumer spending should rebound. The first quarter GDP of 0.7% was below consensus estimates due to weak consumption levels.2 Household spending was dampened by a drop in motor vehicle sales. Inflation levels rose, with the core personal consumption expenditure index increasing to an annualized 2.0% level.2 Looking ahead, we expect consumer spending and overall growth will rebound in the coming quarters.
2. Prospects for tax reform are hazy but imply pro-growth action. Donald Trump’s tax blueprint released last week was a broad outline pointing to a desire to reduce corporate tax levels and push for economic stimulus. It also appears the administration would allow for a modest deficit increase to achieve its goals. The lack of specificity suggests the president is open to negotiation with Congress, and it could be several months before we see specific legislation. Trump and Congress may shift their focus from overall tax reform to targeted tax cuts, which would probably be easier to pass.
3. Corporate tax cuts would likely stimulate earnings. It seems increasingly likely that corporate taxes will be cut at some point over the coming months, which could be a boon for earnings and profits. According to calculations from Standard and Poor’s, a 4% reduction in the effective tax rate from 27% to 23% would raise S&P 500 earnings by about $5 per share.3
4. The shifting macroeconomic environment should benefit individual security selection within equities. Since the end of the financial crisis, global central banks have kept interest rates extremely low, often referred to as “financial repression.” This trend appears to be ending, and we believe fiscal, regulatory and trade policies are more important than monetary policy as drivers of financial markets. As the era of financial repression draws to a close, we expect security-specific fundamentals will increasingly drive valuation measures. This shift should make security selection increasingly important and create an environment for active managers to add value.
The Outlook for Equities Remains Solid
Equity markets have generally been consolidating for the last couple of months. Although short term hurdles remain and further consolidation is possible, the big picture outlook appears positive. In the immediate aftermath of the election, equities were boosted on hopes of a significant economic acceleration resulting from massive fiscal stimulus or a significant overhaul of tax policy. Those hopes have been fading. We still expect to see some form of stimulus and tax reform, but the specific packages may be smaller than previously hoped for and the timing may be later than earlier expected.
The good news, however, is that both economic and earnings growth could improve over the rest of the year. At the same time, inflation expectations remain relatively contained and interest rates are still low, which should provide a tailwind for equity prices. As such, we believe near-term caution is warranted but expect U.S. and global stock prices to rise over the next 6 to 12 months.
We anticipate global equity markets as a whole to remain relatively solid, and leadership may shift from U.S. to non-U.S. markets. During the financial crisis in 2008 and 2009, the United States was much more aggressive than other developed markets (particularly compared to the eurozone) to engage in emergency stimulus. This action helped contain the ensuing recession and prompted a faster growth reacceleration. Largely as a result, U.S. equities have been outperforming for several years. This gap finally appears to be drawing to a close, and we wouldn’t be surprised to see non-U.S. equities be quite competitive compared to U.S. stocks this year.
Bob Doll is chief equity strategist at Nuveen Asset Management.