ECONOMIC AND STOCK MARKET COMMENTARYSubmitted by Ralicki Wealth Management & Trust Services on March 1st, 2017
The nation’s economy is clearly holding its own as we move through the early weeks of 2017. In fact, in certain respects, things look better now than they did three months ago. To be sure, gross domestic product growth did slow from the third to the fourth quarter, with respective increases of 3.5% and 1.9%. However, the third-quarter gain was inflated by a surge in exports and a pickup in federal government spending—neither of which was sustained in the final three months of the year. All told, if we exclude the export component from both periods, GDP growth would have been in the mid-2% range in each quarter. Importantly, even as headline growth slowed, the contributions from residential and nonresidential construction rose nicely, while personal spending held its own. As such, core components of the expansion remained in place as a new year began.
There seem to be more tailwinds than headwinds in place. On point, recent years have seen the economy run into opening-period difficulties, most often from weather-related issues, and in 2016 from falling commodity prices—notably oil—as well. This year, the first quarter began with a prevailing wind at the economy’s back. To wit, energy sector capital investment is rebounding following sizable reversals a year ago, as the rig count is climbing again. Moreover, building permits and housing starts are holding up nicely; non-defense capital spending is rising; and consumers, buoyed by gains in disposable income and household wealth, remain supportive. Finally, the jobs outlook is brightening, with the January employment tally up strongly. All of this, along with record-high stock prices and sharp increases in the leading indicators, suggests that first-quarter growth could exceed 2%. At this point, only excessive inventories figure to be a material problem early in the year. But the current drawdown in such stockpiles could be a boon to output later on in 2017.
Growth should accelerate modestly over the balance of this year and into 2018. The supportive trends cited above, along with the usual spring thaw following what thus far has been a cooperative winter in many regions, should see growth of 2.2%-2.5% in the second quarter, assuming no sizable inventory corrections or big reversals on the trade front. Growth in the final half then would figure to average just north of 2.5%, based on expectations of additional strength in consumer spending, capital investment, and housing. Our economic model incorporates a further pickup in growth in 2018, as the expected fiscal stimulus undertakings kick in. Potential flies in the ointment could be a trade war, a fiscal policy misstep, monetary miscalculations by the Federal Reserve, or unsettling military events overseas. In our view, 2018 probably will mark the high point of the business cycle, with growth of close to 3%. A modest deceleration in the rate of business improvement would seem logical as the decade turns.
Meanwhile, things rarely go according to design, and this long-in-the-tooth expansion probably will be no exception. True, the recent economic strides do offer encouragement, and it is conceivable that the seemingly more business-friendly attitude of the Trump Administration (with regard to the tax structure and lessening regulation) should yield above-trend (at least for this cycle) GDP growth in 2018, when much of this anticipated program might be in place. Still, with a more confrontational attitude in Washington and with an aging upturn likely to gradually bring on moderate inflationary pressures and less-accommodative Fed policies, the orderly business advance that we are projecting could show a few wrinkles along the way. For now, though, our 3- to 5-year projections do not incorporate a recession, nor do we look for sustained growth of more than 2.5% given the wealth of underutilized capacity still in place. As before, the greater risks to sustainability would seem to be global in nature.
THE STOCK MARKET
As noted, there was a strong increase in equity prices following the election of Donald J. Trump on November 8, 2016 as the 45th President of the United States. Specifically, leading up to his surprise win, the Dow had been holding in the 18,300 area. Since then, the index has surpassed 20,800—for a post-election surge of more than 13%. The increase was almost as large for the S&P 500 Index, while the NASDAQ, underpinned by solid gains in selective technology stocks, has risen by close to 13%. A sense the new Administration would have a more business-friendly tone to it—given the early emphasis on tax cutting, the loosening in regulations, and the likely rise in infrastructure spending—has proven reassuring to investors. Also helping, of course, was the strong earnings performance and the promise of more corporate advances to come.
Now, though, the stellar showing by equities has lifted valuation measures again. To wit, price-earnings multiples for all stocks with earnings have climbed into the 20 range—a P/E that would seem to assume that most everything will go right in the months ahead. That is a big assumption, of course, as negative surprises will always be around, with possible disappointments on the domestic political stage, in the fiscal arena, on the monetary side, and, perhaps most critically, on the global scene likely to take their turn in potentially disrupting the orderly behavior of the financial markets. Such exposure is clearly greater when markets are frothy, as is the case currently.
Conclusion: We are cautious on equities, in large part due to the elevated level of the market. Thus, even though the backdrop still is accommodating, the risks now appear somewhat greater to the downside than not.