Stock markets around the globe demonstrated strong and steady performance in the first quarter of 2017. The S&P 500 Index produced total returns of 6.1% in the first quarter while experiencing unusually low volatility. There was only one day when the index closed down more than 1%. The same quarter in 2016 had 15 days with a loss of 1% or more. Unlike last quarter, when “Trump Rally” gains were largely attributed to hopes of lower taxes, deregulation, and infrastructure spending, the current quarter’s performance seems to be linked to optimism regarding global economic growth and an improving outlook for corporate earnings.
The table below shows the performance of major equity indices for various time periods.
Equity Performance for Periods Ending on March 31, 2017
|Total Return Index||Market Sector||Quarter||1-year||3-year||5-year||10-year|
|S&P 500||Large U.S. Companies||6.1%||17.2%||10.4%||13.3%||7.5%|
|Russell 2000||Small U.S. Companies||2.5%||26.2%||7.2%||12.4%||7.1%|
|MSCI EAFE||Developed Int’l Markets||6.5%||8.5%||-2.2%||2.9%||-1.8%|
|MSCI EM||Emerging Int’l Markets||11.2%||14.5%||-1.2%||-1.7%||0.3%|
From Election Day to year-end, financial, energy, and industrial stocks rose sharply as many believed these sectors would benefit from deregulation and infrastructure spending (see following table). Small company stocks rose sharply in anticipation of lower U.S. corporate tax rates, as more of their profits are earned in the U.S. compared to larger companies. International investments performed poorly due to concerns over trade policy and a decline in the value of foreign currencies. Health care stocks were weaker on fears of price controls on pharmaceuticals and lower reimbursement from government health programs.
The first quarter of 2017 saw an almost complete reversal of sector performance following the election. The best performing sectors from Election Day through the end of the year (Nov. 8 to Dec. 31) have all underperformed in 2017, and the worst performing sectors have all outperformed (Jan. 1 to Mar. 31). The market quickly discovered that change is not easy, it might take a while to implement, and it might not even happen. For example, the Trump Administration’s first major attempt at reform—its promise to repeal and replace Obamacare—was thwarted by opposition from both parties. Tax reform is expected to be next on the agenda, and while it may hold the greatest promise for bipartisan support, it is likely to be even more challenging to accomplish. Changes to the tax code are usually a zero-sum game in that a cut for one stakeholder is an increase on another. The beneficiaries of loopholes are likely to vigorously defend their special status. Talk of a protectionist trade policy has been toned down, and infrastructure spending is likely to meet resistance from fiscal conservatives in Congress.
|Trump Rally||Trump Rally||Subsequent Reversal||Subsequent Reversal|
|Market Sector||ETF Proxy||Nov. 8 to Dec. 31||Versus S&P 500||Jan. 1 to Mar. 31||Versus S&P 500|
|Small U.S. Companies||IWM||13.9%||8.8%||2.2%||-3.7%|
|Developed Int’l Markets||AGG||1.1%||-4.0%||8.1%||2.2%|
|Emerging Int’l Markets||IEMG||-5.3%||-10.4%||12.6%||6.7%|
The Trump Rally, which at first had clear winners and losers, now seems to have morphed into a broad market advance that reflects what is considered to be a pro-business attitude of the new administration. While the market shook off the lack of progress regarding health care reform, it may be more disappointed if tax reform goes nowhere.
A good bit of the stock market’s recent performance can be attributed to strength in the economy and corporate earnings. This is reflected in both the Conference Board’s Leading Economic Index and its Consumer Confidence Index, both of which are at their highest level in over a decade. Claims for unemployment benefits have fallen to their lowest level since 1973. And according to Thomson Reuters I/B/E/S, earnings for S&P 500 companies are forecast to rise 10.0% in 2017, which would be its strongest growth rate since 2011.
While the economic and earnings picture is positive, much of the good news has already been reflected in higher stock prices and valuations. The price/earnings ratio for the S&P 500 (using next 12 months’ estimated earnings) is 17.6, which is at the high end of its 15-year range. While over-valuation is not yet a major concern given growth in corporate earnings and the low interest rate environment, it is hard to make the case that stocks are cheap.
In March, the Federal Reserve increased its short-term benchmark rate, as expected, by 0.25%, to a range of 0.75% to 1.00%. Two more rate hikes are likely before year-end. The yield on the 10-year Treasury bond was virtually unchanged, declining from 2.45% to 2.40% during the quarter. The Barclays Aggregate Bond Index, the broadest benchmark for the U.S. taxable bond market, generated returns of 0.8% in the first quarter. We continue to regard long-term fixed income securities as unattractive due to low yields and the risks related to rising rates.
John D. Frankola, CFA
The author is the president of Vista Investment Management, LLC, a Registered Investment Advisory firm. Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide information and analysis regarding investments and is not a solicitation of any kind. References to historical market data are intended for informational purposes; past performance cannot be considered a guarantee of future performance. Neither the author nor Vista Investment Management, LLC has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.