As we head further into 2017 our market analysis focuses on several topics to help us better understand market implications. By identifying positive from negative implications we can aim for a clearer picture of the economic environment. The following summary was derived from LPL Research’s Weekly Market Commentary, March 20, 2017
Some of the topics that represent positive market implication include Economic Growth, Earnings, Technicals and Corporate Tax Rate, while other topics such as Fed Policy & Interest Rates, Valuations and Trade Policy/Border Tax are associated with having negative market implications.
On economic growth we continue to expect near 2.5% growth in U.S. gross domestic product (GDP) in 2017, roughly in line with long-term averages, supported by improving business investment, steady consumer spending gains, and pro-growth fiscal policy. We expect the Federal Reserve to hike interest rates twice more in 2017. The Fed’s acknowledgement of the improved economic outlook and its plan to hike rates gradually are encouraging.
Earnings are one of the biggest keys for stocks to produce additional gains in 2017. The latest reading near 58 for the ISM Manufacturing Index, historically a good earnings indicator, suggests continued earnings growth (readings above 50 indicates expansion).
The technical indicators for U.S. equities continue to exhibit bullish momentum above shorter and longer-term moving averages, while the S&P 500’s price near all-time highs increases the potential for a sustained bullish trend. As long as the index remains above its 200-day moving average, the long-term price trend remains bullish for stocks.
The current corporate tax rate (35%) is one of the highest in the world and encourages companies to relocate overseas. Bringing the rate down would help keep U.S. companies from moving offshore and boost corporate profits and U.S. economic growth.
We acknowledge rich valuations are a concern. On a trailing four-quarter basis, the price-earnings ratio (PE) for the S&P 500 is over 19, several points above long-term averages in the 16–17 range and above where most bull markets peaked. Longer term, higher valuations have historically translated into below-average returns. However, valuations are not good predictors of near-term stock market performance.
The House tax plan included a provision that essentially taxes imports, but not exports in order to encourage U.S. production — called a border adjustment tax. Although the proposal could be a big source of tax revenue to help pay for the corporate tax cuts, we do not expect this plan as proposed to make it through Congress because of the outsized impact on certain industries. The concern is that a tax on imports could contribute to escalating trade tensions with China and Mexico.
President, Blue Diamond Wealth Management
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All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
The Institute for Supply Management (ISM) Index is based on surveys of more than 300 manufacturing firms by the ISM. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio.
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