- Equities will benefit from continued strength in the U.S. economy
- Trump policies are pro-growth
- Outlook for EPS growth improved
While volatility is likely to increase from recent levels, we believe that 2017 will see positive equity returns and that the secular bull market will continue. We expect the pace and direction for U.S. equities to be influenced by three key factors:
Continued Strength in the U.S. Economy
Due to a number of factors, the U.S. economy enjoyed solid growth in the second half of 2016. We expect a continuation of modest growth in 2017 as fundamentals for the consumer remain encouraging. Growth in jobs has been solid, compensation is rising, and the savings rate has been increasing. Consumer net worth has been helped by rising housing and stock prices, and confidence is on the rise. Despite modest increases in interest rates as a result of the Fed, a stronger consumer bodes well for 2.0-2.5% GDP growth for 2017 and good corporate earnings growth, which is supportive of rising equity prices.
Fiscal Policy and Leadership Initiatives of the Trump Administration
Newly elected President Trump and the Republican-majority Congress are pursuing a pro-growth agenda, including lower taxes for corporations and individuals, deregulation of certain industries, and increased spending on infrastructure and defense. While it will take months for proposals to be finalized, compromises to be made, and budgets to be finalized, we believe something proactive will be accomplished that will have a modestly positive impact on economic growth and ultimately the earnings outlook for companies. However, much uncertainty exists. Mr. Trump has no government experience, his approach to dealing with adversaries and allies is unknown, and whether he will truly pursue policies that are protectionist is anyone's guess at this moment. In other words, will Trump be a president focused on positive intentions or an adversary of free trade and immigration? Depending on Trump and Congress, the resolution of these uncertainties could help or hurt multiples for stocks.
Outlook for EPS Growth and Valuation
Our base case for earnings growth in 2017 is 5.0%, led by 2.0-2.5% GDP growth, 2.0% inflation, and continued stock buybacks. We believe this 5.0% base case can be enhanced by tax cuts. For the moment we are assuming the effective tax rate of S&P 500 companies is reduced from 28.5% to 24.5%, as of July 1, 2017. Assuming this reduction (and all else being equal regarding itemized deductions), our 5.0% growth base case would increase to 9.0%. Should things play out this way, the earnings outlook and demand for stocks would be enhanced and lay the foundation for a positive year for equity returns and a continuation of the secular bull market.
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