Key Points
▪ The equity rally faded as investors began focusing on rising bond yields and the climbing U.S. dollar.
▪ The political backdrop still appears to promote economic growth, but investors are focusing more on specific policies.
▪ Equity leadership has shifted noticeably as markets become more dynamic.
U.S. equities finished mostly lower last week, with the S&P 500 Index down 0.9%.1 Rising interest rates and the climbing U.S. dollar weighed on sentiment, and investors started turning from broad hopes of fiscal stimulus and tax reform to wondering about specifics. And oil prices rallied strongly due to OPEC’s agreement to enact production cuts.
Weekly Top Themes
1. The November payrolls report confirmed that the job market is healing. The numbers were broadly in line with expectations. The unemployment rate fell more than expected to 4.6%, mainly due to a drop in the participation rate.2 Average hourly earnings fell for the first time since last December by 0.1% following a strong 0.4% gain in October.2
2. The manufacturing sector is gaining momentum, as previous headwinds such as lower oil prices have faded. The Institute for Supply Management Manufacturing Survey came in ahead of expectations, while the Output Index reached its highest level in 20 months.3
3. Consumer and business confidence have advanced since the election. This has boosted short-term U.S. economic activity. However, the potential downside includes an increase in mortgage rates and upward pressure on the dollar. Additionally, the political backdrop could cause a jolt to confidence levels if attention turns back to anti-globalization efforts.
4. Treasury yields should experience ongoing upward pressure, but the pace is likely to slow. We expect yields will rise unevenly over the next few years as the economy continues to accelerate and as inflation moves higher, but market action should be more orderly than recent activity.
5. Corporate earnings-per-share growth is accelerating. In November, 6 of the 11 S&P 500 sectors showed upward EPS revisions.4 The overall percentage of upward revisions was 60%, the highest level in several years.4
Market Rotation Is the Real Equity Story
U.S. equity markets appear dominated by two opposing trends. On the positive side, anticipation over possible tax reforms, fiscal stimulus and infrastructure spending, as well as improving investor confidence, are pushing prices higher. Conversely, higher bond yields and the rising dollar are causing concern since these developments could potentially slow economic growth before the positive factors kick in next year.
For most of November, the positive forces won, but concerns are rising that stock prices have run too far, too fast. Additionally, the post-election market environment is shifting as investors are focusing on specific policy questions. There remains a broad sense that President-elect Trump and the GOP Congress will focus on progrowth initiatives. Investors appear reassured by Trump’s mostly traditional political appointees, but the initial euphoria has faded. Investors are looking for specifics about tax reform policies, whether corporate and individual tax reform efforts will be combined and how spending priorities will be sequenced. At the same time, concerns appear to be growing that Donald Trump may be returning to the more combative anti-immigration and anti-globalization rhetoric that dominated his campaign.
To us, the big story within equities is not the intense rally, but the significant rotation in market leadership. Financials (and banks in particular) have soared, while capital goods-related companies also experienced gains.1 Health care stocks rallied immediately after the election, but that rally stalled as investors await specific policy proposals.1 On the other hand, income-oriented and bond proxy sectors have lagged significantly.1 We also see intra-sector dispersions. In technology, undervalued, domestically-oriented segments have done quite well, while traditional growth and more globally-focused companies have lagged.1
In general, we think most of these trends will persist into early 2017, but market leadership is becoming more dynamic. This suggests that investment selectivity is growing in importance, an implicit argument for active management.
1 Source: Morningstar Direct, as of 12/2/16
2 Source: Bureau of Labor Statistics
3 Source: Institute of Supply Management and Markit
4 Source: Citi Research
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000 Index measures the performance approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone.FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.
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The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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