What a difference a year can make. As discussed in the 2016 Fourth Quarter Market Overview it was less than one year ago that markets were in a mini melt-down due primarily to global economic concerns. While we know now that the state of the global economy was never as bad as it seemed, investors had started to convince themselves (and each other) that the worst was coming. Negative headlines dominated - the Federal Reserve (the Fed) had embarked on a pre-set course of economy-destabilizing interest rate hikes, the fallout from the oil price collapse was only just beginning, and a Chinese currency devaluation would drag China, along with the rest of the world, into a recession.
In all fairness, fears with regard to the Fed, the health of the energy industry, and the Chinese currency and economy, were well founded at the time even if the markets overreacted (as they tend to do). While the energy industry has enjoyed a much needed recovery, concerns related to Fed policy and China’s currency still exist today. So why are equity markets, at least in most of the developed world, close to or at all-time highs? The answer is that while global economies entered 2016 in a deceleration pattern, we are entering 2017 on an encouraging upswing. The U.S. and Chinese economies are considerably more robust than they were a year ago, and even the Eurozone is doing quite well.
The 2016 mid-year global economic rebound is illustrated in the table or “heat map” below of the Global Purchasing Managers’ Index, a gauge of economic activity. A score above 50 indicates an acceleration in economic activity, whereas a score below 50 indicates deceleration. As the color coding varies (red = weakest reading, green = strongest reading), the weaker readings by region or country were concentrated in the first part of the year with a recovery starting mid-year and accelerating rapidly into year end.
While the economy clearly began to show a positive pickup well before US elections in November, we’d be remiss if we didn’t mention the impact the US presidential election has had for economic growth expectations, particularly here at home. Post-election expectations have taken a marked shift higher due to President-elect Trump’s pro-growth agenda. Following years of underwhelming growth after the financial crisis, many economists conditioned themselves (and us) to expect more of the same into the future. Promises of lower tax rates, deregulation, infrastructure spending, repatriation of corporate cash and other agenda initiatives by the President-elect swiftly changed this expectation. It is still too early to tell what policy initiatives will come to fruition and when their impact will be felt, but as we argued in our piece Does Economic Growth Really Drive Equity Returns?
it is not so much the actual level of economic growth that matters, but the element of “surprise.” In this case, the possibility of renewed growth was all the “surprise” economists needed to awaken from their low but steady growth forecasts.
In a Wall Street Journal post-election survey of economists on average they now expect growth to expand to 2.2% in 2017 and 2.3% in 2018, up from the 1.5% experienced over the past 12 months. One not insignificant risk with this increase in growth is that inflation is also seen ticking higher at 2.2% (2017) and 2.4% (2018) which would be the first sustained period above 2% since before the financial crisis of 2008.
The current acceleration in growth and optimism surrounding the pro-growth policy initiatives will likely keep the economy on a positive trajectory near term. As we progress through the year and further into the Trump administration’s tenure, the success or failure of delivering on the ambitious agenda also presents the greatest challenges and potentially the greatest market risks.
For a more detailed look at the market in the quarter just ended, read our Market Overview here or our Asset Class Summary here.
Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.