The Dow Jones Industrial Average continued its post-election ascent through February, hitting an all-time high of 21,115 on March 1. From the pre-election low to the March high, the market rose 18%. Since the election, investors bid up stock prices in anticipation that the impact of reduced regulations and fiscal stimulus would substantially boost corporate earnings.
The Trump administration worked quickly after inauguration day to sign executive orders delaying implementation of new regulations such as the Department of Labor’s Fiduciary Rule that was set to go into effect this April. As White House efforts turned toward more substantive and permanent changes, the administration suffered its first legislative setback. This caused the market to decline 2% during the month of March.
Over the 7 years since the Affordable Care Act’s passage, a major focus of the Republican Party has been its repeal. The American Health Care Act, which would have repealed and replaced the ACA, was the first piece of legislation that the Republican majority in Congress and the Trump administration attempted to pass. On March 24, Speaker of the
House Paul Ryan pulled the bill from consideration, stating that there were not enough votes for passage. This calls into question whether the Trump Administration has the ability necessary to get a bill through our political process.
The post-election market gains were largely driven by an expansion of price-to-earnings valuations. With a lack of confidence in Congress and the administration’s ability to pass legislative reform, we worry that we will see market valuations contract to pre-election levels.
Higher interest rates also put pressure on stock market valuations. In mid-March, the Federal Reserve raised its benchmark rate for the third time since the financial crisis, although this was only the second raise in three months. The benchmark range was raised 0.25% to 0.75% – 1.00%. The Federal Reserve is responding to the underlying strengthin the U.S. economy. We anticipate that this is the first of three rate increases in 2017.
Regardless of whether or not we see further legislated stimulus, strong economic fundamentals should drive earnings higher. After oil sector earnings declines over the last two years, corporate earnings as a whole are now poised to rise. S&P earnings are projected to rise from $108 in 2016 to $129 in 2017. These estimates are probably overly optimistic in light of the recent political stumbles. However, corporations are in good shape: cash as a percentage of assets has doubled since 2000 and payroll growth has been strong.
The economy is also in good shape. March unemployment claims of 223,000 were the lowest in 44 years. The labor market looks good, inflation is just starting to pick up and consumers as a whole have recovered from their financial crisis woes.
Consumer households continue to strengthen. Household net worth is at an all-time high. Consumer confidence and sentiment measures indicate that the consumer spending should continue unabated. Foreign developed markets performed well in the first quarter, however the overseas markets are being affected by political changes. British Prime Minister Theresa May triggered Article 50, the provision that puts in motion the UK’s official exit from the European Union. This occurred amidst negotiations with Scotland and Northern Ireland about their participation in the economically independent UK.
The upcoming French election will provide another interesting data point for the global trend of rising nationalism. The leader of the National Front Party, Marine Le Pen, has been a vocal critic of the European Union and has pledged to seek an exit for France. We think these issues create headwinds for developed foreign economies and stocks.
Earnings growth should support current market levels or potentially push it slightly higher. The downside risk is that we do not see legislative progress towards regulatory and tax reform, which we think we could cause P/E contraction to pre-election levels of 19 times. If this occurs, and if earnings growth continues as projected, the market would likely hover around current levels.
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