Review
The beginning of 2017 saw the stock market continue to ride strong momentum following the presidential election. The first quarter started off with high expectations that the incoming Trump administration would deliver on his campaign promises to boost the economy with deregulation, tax reform, and fiscal stimulus. But in the final month of the quarter expectations waned as the President and the GOP controlled congress failed to reach an agreement on healthcare reform. Since the President’s plan was to deal with healthcare reform before his other agenda items, this pushed his pro-growth agenda out further into the future. In turn this lead to underperformance of “Trump trade” stocks like financials and industrials as the quarter ended.
Even though the market lost some momentum at the end of the quarter, performance was solid. The large cap S&P 500 Index ended the quarter up 6.07%, its biggest quarterly gain since the end of 2015. Also of note, the Dow Jones Industrial average surpassed 20,000 for the first time.
A notable change of trend in the quarter was the outperformance of growth stocks, specifically the technology sector, which was up 12.16%. For most of 2016 and particularly after the election, many growth stocks were out favor and underperformed value stocks found in the financial, industrial and materials sectors. The quarter also saw large company stocks outperform small companies, with the large-cap Russell 1000 index up 6.03% vs. the small-cap Russell 2000 index up 2.47%.
Bonds seemed to be taking their cue from the delay of Trump’s pro-growth agenda by essentially ending the quarter where they began. At quarter end the 10-year US-Treasury yield was 2.40% vs. 2.43% the end of 2016.
Following its March meeting, the FOMC raised the target fed funds rate by 25 basis points to a range of 0.75%-1.00%. This is the first interest rate change for 2017 and expectations are for two more increases by year end. The FOMC meets again during the first week of May, and it will consider another interest rate hike and hopefully give investors clues about their crisis era balance sheet. If inflation trends higher and employment remains strong, the Fed may raise the target rate to 1.25% following the May meeting. Should positive economic momentum persist, then one more rate hike will be likely by year end.
Outlook
With Trump’s agenda somewhat in question, investors will be paying close attention to first quarter earnings. We expect first quarter earnings to be robust, since having just gone through an earnings recession, where negative earnings were reported for five consecutive quarters, Q2 2015 through Q2 2016, S&P 500 companies face easy year-over-year earnings comparisons.
According to FactSet, the first quarter earnings growth rate estimate for the S&P 500 is 8.9%. If achieved, that will mark the highest earnings growth for the index since Q4 2013. In addition, FactSet details that out of the eleven S&P 500 sectors, eight sectors are projected to report year-over-year growth in earnings, led by the Energy, Financials, Materials, and Information Technology. For all of 2017, analysts are projecting earnings growth of 9.8% and revenue growth of 5.3%.
While 2017 earnings expectations are positive, growth in 2018 will largely hinge on the passage of pro-growth economic policies like tax reform, de-regulation and infrastructure spending and how far the Federal Reserve tightens monetary policy.
Since we believe stock prices tend to follow profit growth we are positioning private client portfolios in areas where robust earnings are expected.
Please let us know if you would like to discuss our outlook and strategy.
Sincerely,
Nadim "Joe" Nahas, CWF®, AIF®
Co-Founder/Portfolio Manager