Is the Trump Bump Becoming the Trump Dump?
Stocks are off to a terrific start so far in 2017, with the S&P 500® Index advancing 6.07% in the first quarter, international markets up 7.25%, and emerging markets even stronger at 11.44%. A style rotation continued during the quarter, with growth benchmarks outperforming value indexes and large stocks outperforming small stocks—the opposite of what happened in 2016. The asset classes and equity sectors that benefited the most from Donald Trump’s surprise election cooled off and have lagged materially so far this year. (See chart: 2016 Democratic Portfolio Relative to the Republican Portfolio).
Bonds reversed course in the first quarter after a difficult fall. The broad U.S. bond market advanced 0.82%, California municipal bonds returned 1.57%, high yield was up 2.71%, and emerging market debt increased 3.90%. Importantly, the yield curve flattened during the first quarter, with the U.S. Federal Reserve raising short-term interest rates one quarter of a point, but longer term interest rates barely budged (See chart: U.S. Yield Curve). The 10-Year U.S. Treasury yield actually fell slightly, from 2.44% a quarter earlier to 2.39%, as did the 30-year rate, which fell from 3.07% to 3.01%. Investors are now grappling with how much of Trump’s agenda will actually make its way into law and when it will occur.
The failure of the Obamacare repeal and passage of a suitable replacement has led to questions about how much of President Trump’s agenda will actually be enacted by Congress. Even though the Trump Administration has pivoted towards tax reform, the market doesn’t seem to have much confidence that agenda will be accomplished any time soon (See chart: Companies with High Tax Rates Relative to the S&P 500® vs. Companies with Low Tax Rates Relative to the S&P 500®).
Cyclical stocks, which have the most to gain from the passage of Trump’s agenda, have lagged defensive stocks so far this year. So why are stocks continuing to perform well? Since last summer, improving energy prices and economic growth in many foreign markets have been driving a steadily improving U.S. economy. In addition, corporate earnings have stopped declining (after two years of being in decline), and are actually starting to accelerate. Also contributing to the climb of the stock market is the fact that CEO and small business optimism has soared now that the uncertainty of the presidential election is behind us and investors see Trump’s administration as more pro-business (See chart: Small Business Sales Growth Expectations). Such optimism is more likely the result of investors believing that the election of a Republican majority in Congress and the White House will spell the end of increasing regulation and taxes rather than investor confidence in the ability of President Trump and Congress to work together to pass the legislation.
One of the largest question marks of Trump’s presidency as he entered off ice was how his administration would deal with our trading partners. So far, it appears his stance on trading with Mexico (NAFTA) and China, in particular, has softened from his campaign rhetoric. Despite the fact that the Trump Administration frequently garners negative headlines, the stock market has tended to focus on improving domestic and foreign profits, as well as the rampant innovation and disruption at the corporate level.
We believe the stock market and business activity are off to a good start. Globally, corporate sentiment and the business environment seem to be improving, which is a quite a change from the last several years (See chart: Global Earnings). Trump’s policy agenda is becoming clearer than it was during the election. However, it is still too early to declare that we have all the details on his agenda for trade policies and foreign affairs.
We believe improving business sentiment will translate into improved growth, assuming the price of crude oil stabilizes in the $45 to $60 range. We expect GDP growth to be in the 2.5% to 3.5% range and S&P 500 earnings-per-share growth, which we estimate will be in the high single digits, to pick up over the remainder of the year and into 2018. In the fixed income market, we still believe there will be some modest upward pressure on longer-term bond yields as the year unfolds. Corrections in the equity market may occur at any time, but conditions for a more meaningful equity bear market do not seem to be in place. Our patience in not overreacting to last fall’s Trump rally has been rewarded. We’ll adjust our portfolios if Trump’s actual initiatives become reality, rather than speculation or random proposals. From a stock selection perspective, we’ll continue to focus on quality companies with protective moats that can do well in both good and bad economic times.
The S&P 500® Index is a market capitalization weighted index which includes 500 of the largest companies in leading industries of the U.S. economy. The MSCI® EAFE Index is a free float-adjusted market capitalization index that measures developed foreign market equity performance, excluding the U.S. and Canada. The MSCI® Emerging Markets (EM) Index is a free-float adjusted market capitalization index tracking the equity performance of global emerging markets. The JP Morgan Emerging Markets Bond Index Global is a benchmark index for measuring the total return performance of international government bonds issued by emerging market countries that are considered sovereign (issued in something other than local currency) and that meet specific liquidity and structural requirements. The Bloomberg Barclays U.S. Aggregate Bond Index is a market value weighted index that tracks the daily price, coupon, pay downs and total return performance of fixed-rate, publicly placed, dollar-denominated and non-convertible investment grade debt issues with at least $250 million par amount outstanding with at least one year to final maturity. Performance is calculated on a total return basis with dividends reinvested. The Bank of America Merrill Lynch U.S. High Yield Index tracks the performance of U.S. dollar denominated below-investment-grade corporate debt publicly issued in the U.S. domestic market. The Bloomberg Barclays California Municipal Bond Index is a market capitalization-weighted index of California investment-grade municipal bonds with maturities of one year or more.
This report is based on the assumptions and analysis made and believed to be reasonable by Advisor. However, no assurance can be given that Advisor’s opinions or expectations will be correct. This report is intended for informational purposes only and should not be considered a recommendation or solicitation to purchase securities. Past performance is no guarantee of future results.
Past performance is not a guarantee of future results.
Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.