In the U.S. at the moment, politics seem to be sucking all the oxygen out of the room as far as news coverage is concerned. But this masks the fact that, at a fundamental level, corporate America is steadily improving. As we near the end of the fourth quarter reporting season, earnings growth for the S&P 500 has risen over 5%.This will be the first time the S&P 500 has seen year-over-year earnings growth for two consecutive quarters since the fourth quarter of 2014.
True, management outlooks have been cautious (somewhat understandable given the political uncertainty), but earnings calls have been upbeat. These developments are providing additional fuel for the U.S. equity market, with Financials, Technology and Health Care sectors leading the charge. The laggards have been Energy and Industrials, but even here there are grounds for optimism, with declines in commodity prices, for example, much less than in prior quarters.
Elsewhere, inflation indicators are ticking up, as are other measures of economic growth such as purchasing managers indices (PMIs). Inflation in particular helps nominal growth, and it’s worth reminding ourselves that companies report in nominal, not “real,” dollars.
With inflation picking up, the U.S. Federal Reserve has been busy telegraphing its intentions with regard to interest rate policy. The next move up probably won’t come in March, but more likely in May or June. The financial sector, and banks in particular, are highly sensitive to short-term interest rate movements; any change has an almost immediate impact on their bottom line—that’s another reason why this sector has been enjoying a resurgence.
Elsewhere, international markets have also been beneficiaries of the rise in the U.S. market, with Europe and Asia continuing to edge higher, supported by accommodative central bank policy and improving data. Indeed, today there is more synchronized global growth recovery than there has been in a number of years. Of course, events on the horizon could derail this process, particularly in Europe with its raft of upcoming elections; but the overall momentum, at least for the present, is upward.
Three Policy Drivers
Since the U.S. election, the three pillars supporting the market’s new-found exuberance have been the proposals under discussion by the administration to reform the tax code, to provide regulatory relief and to invest more in infrastructure projects. These three initiatives are what markets are fixated on. But as I observed in an earlier CIO Weekly (“Hopes and Fears,” January 29, 2017), there are concerns that they will take much longer than anticipated to implement. Further complicating this process is the movement to “repeal and replace” Obamacare. This appears to be first on the agenda, particularly for House Republicans. It could delay some of the administration’s priorities, and markets may get frustrated with lack of movement on taxes, regulation and infrastructure.
The uncertainty has led to some valuation concerns for U.S. equities. True, P/E multiples are at the higher end of their historical range, somewhere between 17 and 18 times earnings. But if earnings prove supportive, we see no reason to be overly concerned. Of course, a degree of caution is warranted. If growth or inflation accelerates too quickly, the Fed may hike rates sooner, leading to pressure on the U.S. dollar, but our sense is that the Fed will remain accommodative and cautious in their approach.
I have no doubt that U.S. headlines will continue to be dominated by politics in the months ahead. But it’s important to remain focused on what’s happening at ground level. The fourth quarter results are encouraging and the outlook for corporate America remains sound. As investors plot their next move, they should be mindful of the risks while remaining focused on the long-term fundamentals.
In Case You Missed It
- U.S. Producer Price Index: +0.6% in January month-over-month and +1.6% year-over-year
- U.S. Retail Sales: +0.4% in January
- U.S. Consumer Price Index: +0.6% in January month-over-month and +2.5% year-over-year (core CPI increased 0.3% month-over-month and 2.3% year-over-year)
- U.S. Housing Starts: -2.6% to SAAR of 1.25 million units in January
- U.S. Building Permits: +4.6% to SAAR of 1.29 million units in January
What to Watch For
- Wednesday 2/22:
- U.S. Existing Home Sales
- FOMC Minutes
- Eurozone Consumer Price Index
- Friday 2/24:
- U.S. New Home Sales
Statistics on the Current State of the Market – as of February 17, 2017
|S&P 500 Index||1.6%||3.4%||5.3%|
|Russell 1000 Index||1.5%||3.3%||5.4%|
|Russell 1000 Growth Index||1.5%||3.6%||7.1%|
|Russell 1000 Value Index||1.5%||3.0%||3.8%|
|Russell 2000 Index||0.8%||2.9%||3.3%|
|MSCI World Index||1.3%||2.6%||5.1%|
|MSCI EAFE Index||0.9%||1.4%||4.4%|
|MSCI Emerging Markets Index||1.0%||3.3%||9.0%|
|STOXX Europe 600||0.9%||1.3%||3.4%|
|FTSE 100 Index||1.0%||3.2%||2.7%|
|CSI 300 Index||0.2%||1.0%||3.4%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.1%||0.2%|
|Citigroup 10-Year Treasury Index||-0.1%||0.2%||0.2%|
|Bloomberg Barclays Municipal Bond Index||-0.2%||0.1%||0.7%|
|Bloomberg Barclays US Aggregate Bond Index||0.0%||0.2%||0.4%|
|Bloomberg Barclays Global Aggregate Index||0.1%||-0.2%||0.9%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.1%||0.1%||0.4%|
|BofA Merrill Lynch U.S. High Yield Index||0.2%||0.7%||2.1%|
|BofA Merrill Lynch Global High Yield Index||0.2%||0.5%||2.3%|
|JP Morgan EMBI Global Diversified Index||-0.1%||1.2%||2.6%|
|JP Morgan GBI-EM Global Diversified Index||0.1%||1.3%||3.6%|
|U.S. Dollar per British Pounds||-0.4%||-1.2%||0.6%|
|U.S. Dollar per Euro||0.1%||-1.6%||0.8%|
|U.S. Dollar per Japanese Yen||0.7%||-0.2%||3.4%|
|Real & Alternative Assets|
|Alerian MLP Index||-0.1%||2.3%||7.3%|
|FTSE EPRA/NAREIT North America Index||0.1%||1.7%||1.3%|
|FTSE EPRA/NAREIT Global Index||0.2%||2.1%||3.2%|
|Bloomberg Commodity Index||-1.4%||0.6%||0.8%|
|Gold (NYM $/ozt) Continuous Future||0.3%||2.5%||7.6%|
|Crude Oil (NYM $/bbl) Continuous Future||-0.1%||1.8%||0.1%|
Source: FactSet, Neuberger Berman.