2017 FIRST QUARTER COMMENTARY

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INVESTOR SENTIMENT

Investor sentiment is one of the most elusive and obscure of major stock market indicators and yet, one of the most powerful forces in moving market prices.  Also, sentiment can change quickly as happened immediately after the November 8 election.  Most traditional sentiment indices (such as those of the University of Michigan, the Conference Board, AAII bull/bear ratio and Sentiment Trader) registered a rise in bullish sentiment immediately after the election.  A Gallup/Wells Fargo survey showed that investors are currently the most optimistic in the past nine years and the Conference Board’s Consumer Confidence Index jumped to 113.7, the highest level since 2001. (See Appendix)

The post-election spike in optimism that resulted from the proposed pro-business policies of the Trump campaign is a rational reaction, although based largely on anticipated future actions by government.  The leaders of both political parties have expressed the view that US corporate taxes, among the highest in the world, should be reduced.  Relief from burdensome regulations (that were estimated to have cost $1.8 trillion in 2014 i.e. $15,000 per household) is a priority for the administration.   Also, history shows that the tax reductions implemented by the Kennedy, Reagan and Clinton administrations were each followed by periods of strong economic growth.

ECONOMY

The US economy was showing improvement before the election with the Leading Economic Indicator Index moving higher in 2016 and this underlying trend is expected to continue through the first half of 2017.  Chart A below shows the Big Four Indicators used by the Business Cycle Dating Committee to determine trends in the overall economy.  The BCDC data indicates steady growth even though this recovery has been slower than prior recoveries.

Only manufacturing had been declining, but Chart B shows New Orders bottoming in July and rising through the 2nd half of 2016.  Thus, it appears that US Manufacturing is recovering while Real Retail Sales, Real Personal Income and non-farm Employment continued to steadily advance.

A strong case can be made that investor optimism in anticipation of  more rapidly improving economic conditions as promoted by the president-elect can be realized, at least in part.  The following changes could have a very significant positive impact on future earnings as well as consumers’ ability to increase spending and boost economic growth:

 

  • Middle class tax reductions
  • Corporate tax rates cut to 15%
  • Capital gain rates cut to 15%
  • Repatriation tax cut to 10%
  • Major reduction in business regulations
  • Major new fiscal spending programs:
    • Infrastructure i.e. roads, bridges, airports
    • Military re-equipment including nuclear weapons

 

Only time will tell, but if pro-growth policies are implemented by the new administration, the economic and investment environment could shift from one of slow growth and low interest rates (“lower for longer”) to a much higher rate of growth.  The president-elect has announced a government supported partnership with the private sector that will (1) initiate fiscal investments in infrastructure, (2) increase private capital spending and (3)reduce burdensome regulations on small business – all designed to stimulate more rapid growth.

STOCK MARKET RALLY

We believe the post-election rally is reflecting a paradigm shift in investor sentiment.  All of the major stock indices are at or near all-time highs and the Dow Theory Forecast recently gave a BUY signal.  The stock market, one of the best leading indicators, is forecasting an improving investment climate and re-affirming a continuation of the Long-Term Secular Bull Market that began in 2009.  While we would like to say that Mr. Market is always right, stock prices sometimes get ahead of the inherent value of the underlying securities.  In such events, stock prices pull back periodically creating buying opportunities for investors.  At this time, most indications are that 2017 could see faster economic growth (GDP +3% est.) and an end to the range bound stock market trend prevailing prior to the November election.

2017 OUTLOOK

There are long-term financial concerns such as the twin deficits, US balance of trade deficit now running near $500 billion annually and growing US direct obligations of over $20 trillion.   These problems can best be solved with more rapid economic growth as well as renegotiated trade agreements which are implicit in the administration’s proposed program.  (On foreign trade: it is important to understand that US multinational corporations produce locally most of what they sell locally in countries around the world.  Those local sales are four times larger than their export sales.)

More important, however, is that current economic trends and stock market trends are favorable while inflation and interest rates are expected to remain in check.  After five quarters of flat or declining earnings by the S&P 500 companies, earnings estimates show real increases this year even without corporate tax relief.  The forward P/E ratio has increased to about 17X from 15.6X during the current rally, but possible corporate tax reductions later in the year should bring the valuation back to mid-range.  Market momentum and sentiment are bullish and market breadth looks strong with 70% of the Russell 3000 stocks above the 200 day moving average.  All major stock market indices are at new highs.   Market leadership in the rally is coming from these sectors; finance, technology, energy and materials.   Fundamental and technical indicators we follow point to stronger economic growth through 2017 and beyond accompanied by the next leg up in the Secular Bull Market.

We are pleased to have the opportunity to work with you and will be happy to answer any questions you may have.  Please let us know if your financial position or investment objectives have changed.

Appendix

Charts from a Wells Fargo Report:

“A Constellation of Confidence”

 

Chart 1

*Percentile ranking of U.S. investor confidence since 1987.

Conference Board’s consumer expectation stocks rise less

consumer expectation stocks decline.

Chart 2

*Percentile ranking of NFIB Small Business Optimism Index

since 1987.

Chart 3

*Percentile ranking of Conference Board’s Consumer

Confidence Index since 1987.

Chart 4

U.S. private player confidence*.

*Average percentile ranking since 1987 of U.S. Investor, Consumer

and Business Confidence Indexes.

 

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