March 31, 2017

The year began with the inauguration of President Trump, who quickly issued several executive orders.  Also during the first quarter, Congress failed in its first effort to repeal and replace Obamacare, the Federal Reserve raised interest rates for the third time, and oil was under pressure.  Against this back drop, the markets continued to move higher with very little volatility.  The Russell 1000 Growth Index rose 8.9% and the broad market S&P 500 Index gained 6.1%.  The M&C Inst’l Equity (Large Cap Growth) Composite, Gross of Fees,  outpaced the broad market index while trailing the Russell 1000 Growth Index.

The post-election stock market rally continued in the first quarter with the S&P 500 tacking on over 6% in total return, on top of its 5% fourth quarter post-election advance.  All told, as of the end of the March quarter, the S&P was up 11% since November 8th.  However, there was a notable shift in leadership during the quarter.  The so-called “Trump stocks” (cyclical reflation beneficiaries like financials, energy, materials and industrials) that led the initial advance took a breather and gave way to some of the secular growers within healthcare, technology and consumer discretionary.  The lagging performance of the “Trump stocks” seemed to coincide with a pullback in the dollar and bond yields, a sign that investors’ enthusiasm for the timing, if not the substance, of the Trump administration’s pro-growth agenda, and in particular tax reform, started to wane a bit.  In reflecting further on Trump’s inauguration and the expectations for tax and regulatory reforms, we think it is important to remember that both the current bull market and economic expansion began shortly after former President Obama’s first inauguration eight years ago, so both are getting long in the tooth.

Looking forward, rising energy and bank profits, easy comparisons, and a return to synchronized global expansion all suggest corporate earnings should show further year-to-year improvement after bottoming in the second quarter of 2016.  However, at the same time that doubts are emerging about policy makers ability to fulfill investors’ hopes for improving growth to justify the post-election rally in share prices, we see a growing discrepancy between sentiment-based indicators of economic growth, which continue to show strength, and data reflecting actual economic activity, which have remained soft.  This dichotomy between the so-called hard data and soft data presents a risk for investors that near-term profit growth may prove disappointing.  We currently expect first quarter real Gross Domestic Product to show growth of 1-1.5%, a step down from last quarter’s 2.1%, and the post-recession average of about 2.0%.  While it is possible we could see an inventory-fueled bounce in the second quarter, our expectation is that full year 2017 real GDP is likely to once again be about 2.0%.

We continue to expect 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 CBOE VIX Index, commonly referred to as the “Fear Gauge”, just recorded its second lowest average level on record in the first quarter, and the market just recently went an unusually long 109-day stretch without a 1% move. 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. However, 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.