- Getting the Policy Mix Right
- Investors’ Expectations May Be Hard to Match
- Economy Heads Upward
- Rates Likely to Rise Gradually; Volatility a Concern
- Higher Volatility and Higher Stock Prices Likely in 2017
From the Desk of
GARRETT D’ALESSANDRO, CFA, CAIA, AIF®
The enthusiasm of equity investors anticipating beneficial fiscal policies, including reduced tax rates for individuals and companies along with increases in federal spending, has propelled stock markets to new all-time high levels. The same enthusiasm has led to interest rates reaching levels last seen in 2014. We think the chances for tax reductions and increased fiscal spending are good. What matters is how this enthusiasm translates into better corporate profits and consumer spending.
Assuming the policy initiatives currently being talked about are ultimately passed by Congress, we see modest GDP benefits occurring in 2017 with continued benefits potentially extending into 2018. Whether the reality meets the expectation will be known around the middle of 2017. We believe year-over-year GDP growth in 2016 will be about 1.6% and expect growth to improve to 2.3% for 2017.
The impact to corporate profits can be meaningful, in our view translating into approximately $130-$134 for the S&P 500 in 2017 (up from approximately $123 for 2016, or a 6.0-9.0% increase), assuming significant tax reductions occur mid-year. The main reasons for the improvement in GDP relate to higher business investment spending and better housing markets.
Equity investors will cheer on such strong profit growth, while bond investors will not. There are risks inherent in such expectations. The primary risk is that actual policy changes do not live up to the expectations. It is not possible to know what Congress will actually approve. Other risks include rising levels of wage pressures, leading to increases in inflation, ultimately leading to rising interest rates. This sequence will not, in our view, become problematic in 2017, but could lead to challenging stock markets in 2018.
Historically speaking, rising interest rates (when they occur slowly), are actually accompanied by positive stock returns during the first year of increases. However, by the second year, rising rates begin to negatively impact those returns.
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