March 31, 2017

While investor, business, and consumer confidence levels have increased significantly and remain at elevated levels in hopes that President Trump, together with a Republican-controlled Congress, will boost economic growth through fiscal stimulus measures, there has yet to be any discernable change in the pace of economic activity.  After an increase of 2.1% in the fourth quarter of 2016, it appears that real GDP (Gross Domestic Product) increased at a similar or somewhat lower rate in the first quarter of 2017.  We still believe real GDP growth of about 2% is likely in 2017 with consumer spending remaining steady and business spending showing some improvement.  In the first quarter, however, consumer spending growth did moderate, there was an inventory drawdown, and net exports continued to be a drag on growth, which may have all contributed to a gain of less than 2%.

While we remain hopeful that President Trump’s yet-to-be-announced fiscal stimulus measures will boost economic activity in the second half of 2017 and 2018, we still question how effective these policies will be this late in the economic cycle as structural issues weigh on growth prospects.  There is too much debt throughout the developed world while at the same time demographic and productivity trends are weak.  After the recent failure of healthcare reform, there is also doubt on the timing and size of any fiscal stimulus measures given the increasingly contentious mood in Washington.  Lastly, the Federal Reserve has begun to increase interest rates again and, while we think they will only have to raise them gradually with inflation pressure still moderate, there is a risk that they increase them too much in an economy that has yet to show a noticeable improvement in growth.  The Federal Reserve believes the potential growth of the U.S. economy is 1.5-2.0% and that it is operating at its full capacity.  In their view, any growth above that level would require more forceful action to prevent the economy from overheating and developing damagingly high levels of inflation.  Of course, any increase in interest rates, along with a higher dollar exchange rate, would also limit the effectiveness of any fiscal stimulus measures, particularly with debt levels high throughout the developed world.


We thought there would be a pick-up in stock market volatility in 2017 which would create opportunity and risk for investors.  Thus far, volatility measures for the stock market have remained quite low as the market has continued to advance.  The promise of “phenomenal” tax cuts by the new Administration, low risk of recession, and ongoing monetary accommodation by central banks throughout the developed world have continued to support higher share prices.  With stock market valuations extended – the median price-to-sales ratio for the S&P 500 is at the highest level in the data series – there is a risk that investors are not prepared for any disappointments that may occur with the timing and effectiveness of any fiscal stimulus. With no meaningful improvement in the economy and political tensions high, this risk seems to have increased as has the potential for more stock market volatility.  Any correction in share prices, however, will likely be limited and offer opportunity as recession risk does seem low.  In addition, the Federal Reserve will probably move cautiously as it has throughout this economic cycle when the stock market has experienced turbulence or any meaningful setback, provided inflation does not accelerate above its 2% threshold.  Lastly, President Trump’s pro-growth and market friendly policies, if successful, along with an improvement in corporate earnings will be favorable for the market.

We think our Clients’ holdings are well positioned for the period ahead.  They are reasonably valued on our work and we believe their earnings growth is more assured, which makes them well-suited to provide relative strength in a more volatile environment, while at the same time offering superior potential investment returns over the long term.