In short, we remain constructive on the U.S. and global economic outlooks, but believe that anxiety and economic volatility will probably rise. We think economic growth will remain solid for some time, but risks are growing that the U.S. and global economies will falter in 2018.
The Political Environment Is Becoming More Complicated
For months, the direction of the stock market has closely tracked the political backdrop. When President Trump has focused on possible tax cuts or regulatory changes, equities have generally increased. But markets faltered when he turned his attention to limiting trade or immigration. At some point, we expect investors will more closely scrutinize President Trump’s actual policy actions rather than his rhetoric.
Despite the wide-sweeping nature of many of Donald Trump’s statements, the reality is that the Constitution requires the president to work with Congress to enact legislation. And the judiciary acts as an important check against presidential overreach.
From a practical perspective, this means that the actual tax, spending and regulatory policies the Trump Administration are promising will likely be less far-reaching than many investors hope. We think Washington will pass a fiscal stimulus package, but it will probably take longer than most expect and the scope may well be more modest. The same is likely true with tax reform.
Additionally, the fiscal tone from Washington is somewhat concerning from a budget perspective. President Trump talks about tax cuts, but also discusses areas to increase spending, such as the military. It is unclear how much Congress shares this focus, but we think investors are overly optimistic about the legislative agenda.
We Have Grown Less Bullish Toward Stocks
As a result of these developments, we think the easy gains for equities are in the rearview mirror and we are growing less positive toward the stock market. We do not believe the current bull market has ended, but the pace and magnitude of the gains we have seen over the past year are unlikely to persist.
To be clear, this does not mean we have turned negative toward equities, but we think markets may be vulnerable to negative economic, earnings or political surprises. Market sentiment has improved over the past year while valuations have become less attractive.1 It is somewhat worrisome that investors are becoming more complacent. On balance, we think the near- and long-term equity outlook remains reasonable given the economic and earnings backdrop. It is just that with the S&P 500 currently sitting at around 2,350 at least some positive expectations are already baked into the market.1
From a positioning perspective, we think it still makes sense to remain overweight equities and underweight government bonds. If evidence mounts to reveal a slowing economy or faltering earnings, we would revisit this stance, but we do not expect that to happen for at least the balance of the rest of this year.