The Great Transition
In the January Investment e.Perspective, my colleague Bob Schaefer recounted a conversation with one of our most sophisticated clients. Bob referred to 2016 as "A Year of Upsets and Surprises" and described what was to come in 2017 as "The Great Transition." Following surprise vote outcomes in the US and UK, Donald Trump and Theresa May now have to deliver on the promises made in their respective countries. Meanwhile, in upcoming elections other European countries like France and Italy are facing their own populist movements.
2016 is now rapidly receding in the rear view mirror, but The Great Transition is all around us. As we come to the 100th day of the Trump presidency, just where are we in the transition, and what does it mean for the markets?
- Trade: While Trump's tone on trade remains intermittently combative, it appears we will avoid an all-out trade war with China or other major trading partners. We still expect a protectionist bent to trade policy – as we've seen in a recent tariff on Canadian lumber. However, the worst-case scenarios that caused emerging markets stocks to swoon after the election appear to be off the table for now.
- Taxes: At this writing, President Trump has just announced an ambitious tax overhaul that would cut the corporate tax rate to 15%, a top individual tax rate of 35% and an elimination of the state and local income tax deduction. There is little chance of the president's plan passing congress without significant modifications, but the prospects for a meaningful reduction in tax rates within the next year are good.
- Interest rates: Intermediate and long bond yields have settled down after an initial post-election spike. The late 2016 surge in rates was accompanied by an increase in breakeven inflation, a measure that indicates market expectations for future inflation. The 10-year breakeven inflation rate peaked at 2.1% shortly after the inauguration, but is 1.9% today, suggesting that markets believe administration policy will be less inflationary than originally anticipated. At the same time, the Fed appears determined to raise short-term interest rates at a gradual pace, slowly bringing to an end the extraordinary monetary policy that has been a hallmark of the post-crisis era.
- Economic growth: Consumer and business confidence is high, but those high spirits are not yet coming through in most economic statistics. The Atlanta Fed's GDPNow measure suggests first quarter economic growth may have been as slow as 0.5%, and an April survey of corporate treasurers by the Association for Financial Professionals suggests companies are accumulating, not spending, cash. While Trump's policy agenda is generally pro-growth, most companies are awaiting more certainty before making big investments.
Meanwhile, financial markets are buoyant, with positive results in nearly every asset class. Results in the US are supported both by solid corporate earnings growth and some clarity in the policy outlook. Overseas markets are keeping pace with or surpassing the US due to strengthening growth in Europe, declining fear of a hostile trade environment, and a weaker US dollar. Valuations in the US remain high by most standards, but for now market participants remain optimistic enough about The Great Transition to tolerate high prices in anticipation of continued growth.
The above commentary represent the opinions of the author as of 4.27.17 and are subject to change at any time due to market or economic conditions or other factors.