It’s a new year and there is a new government regime taking over. With it comes new guesses on what lies ahead. Below are some key takeaways and areas that we will be monitoring throughout 2017.
The new administration is promising an economic expansion through tax reform and infrastructure spending. The recent rally may be driven more by the media than actual fundamentals in anticipation of policy changes with the incoming administration. Could this spell inflation?
With unemployment now at 4.7%, it is at acceptable levels. or what many refer to as “Full Employment.” The participation rate may not be where we want it, but as we see wages increase and the new administration touting more job creation, inflation concerns are bound to rise over the next few months, especially if we continue to see a pick-up in the GDP rate.
Result to Stocks: Inflation can be a good sign, meaning there is job growth and the economy is doing well. However, high inflation can also impact corporate profits through higher costs. This causes corporations to worry about the future and stop hiring, negatively impacting the economy. Because there is no one good answer, there is confusion from many on how to invest in periods of inflation.
As we have seen momentum in the stock market over the past few weeks, we have seen the inverse in the bond market. This has been mostly driven by the interest rate increase in December and fears towards inflation. The Federal Reserve Bank talk about accelerating their rate hike increases in an effort to combat premature inflation, most likely will only have minor increases as to not derail economic growth.
Result to Bonds: I expect a lot of noise and volatility in the bond markets to continue throughout 2017 which could create opportunities. We are cautious with holdings in mutual funds as fears could force fund managers to sell bonds within the fund at discounted prices which will affect the returns.
At the end of the day, stock prices rely on how well corporations perform. Earnings grew in the third quarter of 2016 at the best pace since the final quarter of 2014. The index is expected to report positive earnings again for the fourth quarter 2016 which will mark the first time the index has seen year-over-year growth in earnings for two consecutive quarters since 2014.
There could be concerns on global markets about potential trade policies the U.S. may adopt. It is unclear how foreign markets will react as well to an environment of higher interest rates and potentially higher inflation. Europe is under pressure to break up the EU with elections pending in France. This is a wait and see area that we are very cautious about. What happens if the EU breaks up and each country goes back to their own currency? It could happen.