January 3, 2017 • Evan Simonoff
It is sometimes said that history can travel nowhere for decades and then advance decades in a matter of months. Some will view 2016 as a year when time leapt forward while others think it took a major step backward. But nobody could say it stood still. A universal revolt against globalization by everyone except the elites triggered a series of unexpected events reflecting a common sentiment coursing across the world. Yet those unthinkable events were expected to wreak havoc on financial markets and turned out to be only temporary blips. Ever since the financial crisis, the U.S. equity market has emerged as the world’s strongest and global investors’ favorite default option. From that vantage point, the market reaction to an election outcome some claimed could presage the end of Western civilization shouldn’t have surprised so many—the market staged a typical fourth-quarter surge favoring old-economy industrial, financial and energy companies. Between January 1 and December 14, 2016, the Russell 1000 Value index outperformed its growth counterpart by 9.7%, reversing a multi-year trend. Many, including President-elect Donald Trump himself, had predicted a stock market crash, pointing to any number of usual suspects—from central banking policies to over-regulation to sick European banks—as the cause. However, the alacrity with which those same seers bought into the concept of a Trump bull market left the few who had predicted the election result amused. DoubleLine CEO Jeffrey Gundlach told clients in a November webcast that the same people who were predicting that a Trump victory would cause a global depression had no problem reversing themselves and calling for a “global boom.” Color him skeptical. “The word ‘never’ means it’s about to happen,” the bond fund manager remarked. Never was that more true than in 2016. In Gundlach’s view, the problem is obvious. He showed clients a chart of real U.S. incomes from 1973 through 2015. The top 5%, mostly technocrats and professionals, enjoyed a rise of 51.4% while everyone else was down 4.6%. If he had used the top 1%, it would “blow the scale” to absurd proportions. “Citizens are fed up,” Gundlach noted. Citizens may indeed be mad as hell, but equities are frolicking among the buttercups as a powerful secular bull market approaches its eight-year anniversary. Little noticed in the October weeks leading up to the election was the fact that it coincided with the end of a two-year profits recession. It’s noteworthy that the recent profits recession, like the one in 1985, failed to cause an economic recession or derail the current bull market. The president-elect is inheriting an economy nearing full employment, one that Harvard University’s Kenneth Rogoff thinks can grow at 3.0% on its own. Combine Trump’s staunchly pro-business agenda with fiscal stimulus and there’s no telling where the economy and stocks could go, the bulls reason. T. Rowe Price chief economist Alan Levenson and others see virtually zero chance of a recession in 2017. Brexit and the U.S. election may have garnered all the headlines in 2016, but other factors could prove more significant for investors. Northern Trust chief investment strategist Jim McDonald says that the markets were focused too much on the president-elect while downplaying the implications of the Republican sweep of Congress and the White House. The latter development is more important in his view because it breaks the gridlock of the last six years. A consensus is building around the notion that both the bull market and economic expansion are entering new phases. In short, the New Normal could be dead. “It looks like we’ve turned a new leaf,” says Margie Patel, managing director at Wells Capital. “If there are lower taxes and reduced regulations, this could offset a rise in interest rates.” Counterintuitive though it may seem, Patel believes that if yields on money market funds rise to the 2.5% or 3.0% area in the next few years, the relief for long-suffering savers could induce them to invest more in equities. Near-zero interest rates have created a “fear of the dark,” in her view. “It makes people think something is wrong or something is going to blow up,” she says. Euphoria about lower corporate taxes may need to be tempered. President-elect Trump’s advisors have consistently touted a 15% rate, prompting many investors to assume corporations could now keep 85% of their profits, up from 65%. Northern Trust’s McDonald notes that the effective tax rate for the S&P 500 companies is 27%, so the windfall may lack the magnitude some investors believe. But individual companies have different tax rates and some will be big beneficiaries. Larry Puglia, who runs T. Rowe Price’s Blue Chip Growth Fund and its Large-Cap Equity Core Growth Strategy, points to those companies that have relatively high marginal tax rates and derive most of their profits from domestic operations as the winners. This group includes Fiserv, Ross Stores, Charles Schwab, United Healthcare and Alaska Airlines. Then there is the pattern of the presidential cycle and stock market returns. The first year of a new president’s first term isn’t usually particularly propitious for equities. Nonetheless, McDonald expects U.S. equities to return 8% in 2017. This calculation includes 9% earnings growth plus 2% in dividends coupled with valuation compression as equities get more competition from bonds offering higher yields. Brian Nick, the chief investment strategist at TIAA, agrees that expectations need to be tempered. “For the rest of this cycle, equity returns will track corporate profit growth,” he says, arguing the price-to-earnings multiples rarely expand very much in the middle and late stages of the business cycle. Skeptics Unconvinced Not everyone believes in the Trump rally. On December 7, Gluskin Sheff’s chief investment strategist David Rosenberg noted that since the day after the election, the median stock has climbed a whopping 1%. Two sectors, energy and financials, benefit the most from deregulation ideas and represent just over 20% of the S&P 500. “The other 80% of the stock market is flat as a pancake,” Rosenberg wrote to clients. Contrasting the post-election markets following the Trump and Ronald Reagan victories, equities performed far better after the Gipper won a huge victory of surprising magnitude, only to slide 25% in the next 21 months. A combination of “rising bond yields, Fed tightening and a stronger dollar took care of that honeymoon,” Rosenberg wrote. Nearly a week after he sent that piece to clients, the Dow Jones Industrial Average stood within 100 points of 20,000, but Rosenberg wasn’t backing down. “It is incredible” what the market is pricing in because of one man, he declares. It took “the might Reagan” two full years to turn around the economy. Trump, he argues, has the misfortune of entering the White House very late in the economic cycle. Analogies between the Trump and Reagan economies also struck others as misplaced. The current president-elect enters office in very different times and points in the business and market cycles. Rosenberg isn’t alone. “Never once have I seen a presidential election check the course of the business cycle,” MFS chief investment strategist Jim Swanson says. Reagan was inaugurated in the middle of a double-dip recession when equity price-to-earnings multiples were in single digits while interest rates were off the charts. Inflation was eroding consumer purchasing power. But government debt and household debt were low and he had a demographic tailwind at his back. Trump faces a demographic time bomb, high levels of debt, older consumers who haven’t saved enough to retire and an aging economic expansion. Timing aside, Trump is talking about the same type of multi-pronged fiscal stimulus of tax cuts and spending increases in defense and infrastructure that Reagan employed. Fiscal stimulus at this point in the business cycle is highly unusual, Nick says, but it would be more likely to extend the business cycle than shorten it. Some of the infrastructure projects under consideration like airport extensions are long-fused, Swanson says. They require the use of eminent domain, and the necessary permits and approvals can get tied up in courts for years. “What we’re talking about is 20 basis points of GDP,” Swanson estimates. First « 1 2 » Next
It is sometimes said that history can travel nowhere for decades and then advance decades in a matter of months. Some will view 2016 as a year when time leapt forward while others think it took a major step backward. But nobody could say it stood still. A universal revolt against globalization by everyone except the elites triggered a series of unexpected events reflecting a common sentiment coursing across the world. Yet those unthinkable events were expected to wreak havoc on financial markets and turned out to be only temporary blips. Ever since the financial crisis, the U.S. equity market has emerged as the world’s strongest and global investors’ favorite default option. From that vantage point, the market reaction to an election outcome some claimed could presage the end of Western civilization shouldn’t have surprised so many—the market staged a typical fourth-quarter surge favoring old-economy industrial, financial and energy companies. Between January 1 and December 14, 2016, the Russell 1000 Value index outperformed its growth counterpart by 9.7%, reversing a multi-year trend. Many, including President-elect Donald Trump himself, had predicted a stock market crash, pointing to any number of usual suspects—from central banking policies to over-regulation to sick European banks—as the cause. However, the alacrity with which those same seers bought into the concept of a Trump bull market left the few who had predicted the election result amused. DoubleLine CEO Jeffrey Gundlach told clients in a November webcast that the same people who were predicting that a Trump victory would cause a global depression had no problem reversing themselves and calling for a “global boom.” Color him skeptical. “The word ‘never’ means it’s about to happen,” the bond fund manager remarked. Never was that more true than in 2016. In Gundlach’s view, the problem is obvious. He showed clients a chart of real U.S. incomes from 1973 through 2015. The top 5%, mostly technocrats and professionals, enjoyed a rise of 51.4% while everyone else was down 4.6%. If he had used the top 1%, it would “blow the scale” to absurd proportions. “Citizens are fed up,” Gundlach noted. Citizens may indeed be mad as hell, but equities are frolicking among the buttercups as a powerful secular bull market approaches its eight-year anniversary. Little noticed in the October weeks leading up to the election was the fact that it coincided with the end of a two-year profits recession. It’s noteworthy that the recent profits recession, like the one in 1985, failed to cause an economic recession or derail the current bull market. The president-elect is inheriting an economy nearing full employment, one that Harvard University’s Kenneth Rogoff thinks can grow at 3.0% on its own. Combine Trump’s staunchly pro-business agenda with fiscal stimulus and there’s no telling where the economy and stocks could go, the bulls reason. T. Rowe Price chief economist Alan Levenson and others see virtually zero chance of a recession in 2017. Brexit and the U.S. election may have garnered all the headlines in 2016, but other factors could prove more significant for investors. Northern Trust chief investment strategist Jim McDonald says that the markets were focused too much on the president-elect while downplaying the implications of the Republican sweep of Congress and the White House. The latter development is more important in his view because it breaks the gridlock of the last six years. A consensus is building around the notion that both the bull market and economic expansion are entering new phases. In short, the New Normal could be dead. “It looks like we’ve turned a new leaf,” says Margie Patel, managing director at Wells Capital. “If there are lower taxes and reduced regulations, this could offset a rise in interest rates.” Counterintuitive though it may seem, Patel believes that if yields on money market funds rise to the 2.5% or 3.0% area in the next few years, the relief for long-suffering savers could induce them to invest more in equities. Near-zero interest rates have created a “fear of the dark,” in her view. “It makes people think something is wrong or something is going to blow up,” she says. Euphoria about lower corporate taxes may need to be tempered. President-elect Trump’s advisors have consistently touted a 15% rate, prompting many investors to assume corporations could now keep 85% of their profits, up from 65%. Northern Trust’s McDonald notes that the effective tax rate for the S&P 500 companies is 27%, so the windfall may lack the magnitude some investors believe. But individual companies have different tax rates and some will be big beneficiaries. Larry Puglia, who runs T. Rowe Price’s Blue Chip Growth Fund and its Large-Cap Equity Core Growth Strategy, points to those companies that have relatively high marginal tax rates and derive most of their profits from domestic operations as the winners. This group includes Fiserv, Ross Stores, Charles Schwab, United Healthcare and Alaska Airlines. Then there is the pattern of the presidential cycle and stock market returns. The first year of a new president’s first term isn’t usually particularly propitious for equities. Nonetheless, McDonald expects U.S. equities to return 8% in 2017. This calculation includes 9% earnings growth plus 2% in dividends coupled with valuation compression as equities get more competition from bonds offering higher yields. Brian Nick, the chief investment strategist at TIAA, agrees that expectations need to be tempered. “For the rest of this cycle, equity returns will track corporate profit growth,” he says, arguing the price-to-earnings multiples rarely expand very much in the middle and late stages of the business cycle.
Skeptics Unconvinced Not everyone believes in the Trump rally. On December 7, Gluskin Sheff’s chief investment strategist David Rosenberg noted that since the day after the election, the median stock has climbed a whopping 1%. Two sectors, energy and financials, benefit the most from deregulation ideas and represent just over 20% of the S&P 500. “The other 80% of the stock market is flat as a pancake,” Rosenberg wrote to clients. Contrasting the post-election markets following the Trump and Ronald Reagan victories, equities performed far better after the Gipper won a huge victory of surprising magnitude, only to slide 25% in the next 21 months. A combination of “rising bond yields, Fed tightening and a stronger dollar took care of that honeymoon,” Rosenberg wrote. Nearly a week after he sent that piece to clients, the Dow Jones Industrial Average stood within 100 points of 20,000, but Rosenberg wasn’t backing down. “It is incredible” what the market is pricing in because of one man, he declares. It took “the might Reagan” two full years to turn around the economy. Trump, he argues, has the misfortune of entering the White House very late in the economic cycle. Analogies between the Trump and Reagan economies also struck others as misplaced. The current president-elect enters office in very different times and points in the business and market cycles. Rosenberg isn’t alone. “Never once have I seen a presidential election check the course of the business cycle,” MFS chief investment strategist Jim Swanson says. Reagan was inaugurated in the middle of a double-dip recession when equity price-to-earnings multiples were in single digits while interest rates were off the charts. Inflation was eroding consumer purchasing power. But government debt and household debt were low and he had a demographic tailwind at his back. Trump faces a demographic time bomb, high levels of debt, older consumers who haven’t saved enough to retire and an aging economic expansion. Timing aside, Trump is talking about the same type of multi-pronged fiscal stimulus of tax cuts and spending increases in defense and infrastructure that Reagan employed. Fiscal stimulus at this point in the business cycle is highly unusual, Nick says, but it would be more likely to extend the business cycle than shorten it. Some of the infrastructure projects under consideration like airport extensions are long-fused, Swanson says. They require the use of eminent domain, and the necessary permits and approvals can get tied up in courts for years. “What we’re talking about is 20 basis points of GDP,” Swanson estimates.
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