By Gary C. Sanger, Ph.D., CFA
Welcome to 2017! The biggest news this quarter was the election of Donald Trump as the 45th President of the United States. After a few hours of near panic in markets the night of the election, the response since has been very positive. Many Trump policies are pro-business and pro-growth. Only time will tell the longer run effects of the Trump Presidency. And, although U.S. Presidents receive a lot of attention, most research shows that other factors have a greater impact on the direction of markets. The Fed signaled increasing confidence in the U.S. economy, raising the Fed Funds rate by 0.25% in December. After very slow growth in the first two quarters, annualized real U.S. GDP growth recovered strongly, growing by 3.5% in Q3. This is the highest growth in two years, and is slightly above the long run rate of 3.2%. The U.S. leading economic index was unchanged in November, following a 0.1 percent increase in October, and a 0.3 percent increase in September. Details in several key areas follow below.
Consumers – Unemployment continued to decline over the second half of 2016 from 4.9% to 4.6%, a nine year low. Although there is no absolute definition, this is considered to be near or at full employment for the U.S. economy. Employers added an average of 180,000 jobs per month through November. And consumer spending continues to grow, increasing 0.3% in October, following a 0.7% rise in September. Housing continues to strengthen, as the S&P Case-Shiller index is up 5.1% for the year and now exceeds pre-recession levels. The Conference Board’s Consumer Confidence Index increased in December to the highest level since 2001, to 113.7 from 109.4 in November. This reflects improvements in jobs and better overall U.S. economic conditions.
Businesses – Business conditions improved in the second half of 2016, and the outlook is optimistic. Business productivity increased modestly by 3.1% in Q3, but industrial production dropped by 0.4% in November, and is down 0.6% for the year. The U.S. Institute for Supply Management manufacturing index increased in the second half to 54.7% in December. The ISM services index also increased to 57.2% in November. Measures above 50% indicate expansion. Spending on U.S. construction projects rose 0.9% in November, the sixth increase in the past seven months, and spending is now at its highest level in more than a decade. Finally, corporate profits were up 6.6% in Q3, erasing the 0.6% decline in Q2.
Government – After waiting a year after the first post-recession rate increase, the Federal Reserve increased its benchmark lending rate by an additional 0.25% in December to 0.75%. Federal Reserve Chair Janet Yellen stated that the increase was due to improvements in the labor market, and that the number of further rate increases expected in 2017 will increase from two to three. This would put the end-of-year Fed Funds rate at 1.5%. This recent increase was expected for some time, and signals the Fed’s confidence that the economy is improving. The Fed faces a delicate balance. While moving rates toward “normalization” is necessary to prevent future inflation, moving too aggressively could slow growth. While little has been discussed on the fiscal side of the government equation for growth for some time, the new Trump administration brings policy proposals that are widely perceived as pro-growth. Republican majorities in both the House and Senate lead most economists to expect major policy changes on the fiscal side. Lower corporate taxes and higher spending on infrastructure would be pro-growth. However, a tougher stance with major trading partners could offset this if lower exports are the result. I expect uncertainty about the overall results will result in increased market volatility in the interim.
International – The International Monetary Fund’s (IMF) latest World Economic Outlook forecasts that global growth will slow modestly to 3.4% in 2017. While the Fed has begun tightening, most other major central banks are still following quantitative easing (QE) programs, with the hope of stimulating growth. The unfolding of Brexit (The U.K. leaving the European Union) adds uncertainty to the global outlook.
Closing – Both the U.S. and global economies continue on a modest growth track. The impact of the Trump presidency is expected by most economists to be positive for growth, but the high level of uncertainty about fiscal and trade policies suggests higher market volatility. The impact of Fed policy (number and size of rate increases) will also play a major role in economic growth going forward. Finally, unfortunately we cannot rule out the unknown effects of terrorist activity.