- EPS season will be choppy, but should be fine
- Business and consumer confidence should improve after the election
- December rate decision by Fed remains a wild card
There are many significant crosscurrents at work that will influence the returns of U.S. equities through year-end. Foremost among these are corporate profits, the outcome of the U.S. elections, and prospects for a Fed rate hike. While we believe equity markets will be able to move forward in a positive manner during this time frame, investors should expect heightened volatility.
In the coming weeks, Corporate America will report third-quarter results that will provide insights into the level of revenue growth and profitability that companies achieved, as well as their outlook for the fourth quarter and beyond. There are numerous positives and negatives at work. On the plus side, estimates for growth were reduced as the quarter unfolded, so the bar for positive surprises is lower. Also, the dollar should be less of a headwind for results at multinational companies. On the negative side, uncertainty about the election seems to be dampening business confidence and appetites for capital spending and inventory accumulation, which will likely lead to shortfalls for some companies. Overall, we believe earnings season should be fine and companies will likely remain cautiously optimistic about prospects through year-end. This should set the stage for a continued modest increase in EPS growth into 2017.
Uncertainty about the presidential and congressional elections has been high throughout the past few months. The probabilities of a victory by Hillary Clinton assigned by polling organizations such as fivethirtyeight.com have ranged from 50.0% to 86.0% since June. Despite a recent rise in this measure for the Democratic candidate, our view remains that Clinton will win but will not get a sweeping mandate and that Congress will be split. As a result, we believe no meaningful changes in fiscal policy are likely to occur next year to alter the current fundamental trajectory of the economy or corporate earnings. Post-election, we believe political uncertainty will be removed and businesses and consumers will return to normal patterns for spending through year-end and heading into 2017.
The final uncertainty relates to whether the Fed will raise interest rates at its December meeting. While a modest increase in the Fed Funds rate is our base-case scenario (and an improving set of economic signals post-election could increase the probabilities), the Fed may be reluctant to raise rates as, in the short term, such an action would likely lead to heightened uncertainty about the direction of future hikes and put downward pressure on stocks. In the longer term, we believe investors should not fear a rate rise by the Fed, as it would signal confidence in the economy.
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