Key Points
• As Donald Trump is sworn in as the next president, investors are more closely scrutinizing potential economic policies.
• We expect action on the pro-growth Trump agenda, but the pace and scope of legislation may not be as sweeping as many hoped for.
• Despite political risks, economic and corporate earnings fundamentals should provide tailwinds for stock prices.
Investors were highly attuned to the U.S. political backdrop last week as Donald Trump was sworn in as the nation’s 45th president. Expectations remain high that President Trump will deliver on some of his pro-growth policies, but financial markets were rattled by his comments that aspects of the GOP tax plan are “too complicated” and the U.S. dollar is “too strong.” Although 8 of the 11 sectors in the S&P 500 Index were up last week, the index itself moved modestly lower.1
Weekly Top Themes
1. Corporate earnings are clearly improving, thanks to higher interest rates and strengthening business confidence. With 15% of S&P 500 companies reporting, fourth quarter earnings are beating expectations by 4.5% with revenues coming in as expected.2 Current forecasts for earnings per share growth are at 6.4% for the quarter.2 Should the pace of positive surprises continue, earnings could increase more than 10% year over year, the highest level in several years.2
2. The tightening labor market is increasing pressure on the Federal Reserve to raise rates. The latest data shows weekly unemployment claims fell to a 43-year low last week.3
3. Equity markets often experience a downturn after a new president is sworn in. The first months of a presidency often bring political stumbles, increased uncertainty and high levels of scrutiny from investors. In fact, U.S. stocks have declined in February 8 out of the 11 times a new president has taken office, with an average February drop of 4%.4
4. President Trump will need to decide where to exert his political capital. In our view, optimism over the Trump agenda is focused on tax reform/tax cuts, deregulation and infrastructure spending. He cannot act on all of these immediately, and where President Trump chooses to focus first will be telling. We expect quicker action on the tax front compared to other initiatives.
5. Expectations may be too high that tax reform will happen quickly and easily. We expect tax issues to be at the forefront of Washington’s agenda, but President Trump’s comments last week show that he and Congress may not be on the same page. Investors could be disappointed by the pace and final outcome of tax legislation.
This Looks Like a Pause, Not an End, to the Equity Rally
Before the November elections, U.S. economic data started to improve and corporate earnings began experiencing a long-awaited comeback. These factors led to increases in stock prices, bond yields and the value of the U.S. dollar. These trends accelerated sharply following the election, as investors anticipated that Donald Trump and a GOP-controlled Congress would be aggressive about enacting pro-growth economic policies. Since the turn of the year, however, we have seen a modest reversal in all of these financial trends.
To some extent, investors appear more cautious about the political backdrop. Emerging policy differences between the new president and congressional leadership will complicate the legislative process. Additionally, President Trump’s comments on the U.S. dollar and his scrutiny of individual companies’ hiring plans suggest a possible protectionist agenda that could hurt U.S. economic growth.
We agree that political uncertainty is a negative for equities and other risk assets, but we maintain our pro-growth, pro-risk investment stance. We still expect progrowth legislation to be passed, even if it takes longer and winds up being less comprehensive than many hope. The president and Congress have a strong incentive to quickly produce changes to promote political goodwill among their constituents.
More importantly, we think the economic and earnings backdrop remain positive for stocks. The pause in the spike in bond yields and in the value of the dollar take immediate pressure off of the Fed. The central bank will likely continue to raise rates this year, but at a pace that keeps overall policy accommodative. And global monetary policy also remains extremely supportive. Given the strong equity price advances since November, a pause and consolidation should not be surprising, and our long-term forecast remains cautiously optimistic.
Bob Doll is chief equity strategist at Nuveen Asset Management.