US Equities: Policy Smoke or Solid Pillars?

With US equities charging to new heights, some market observers are questioning whether the market is climbing a “wall of worry” based in part on policy promises that haven’t yet been delivered. Grant Bowers, vice president, research analyst and portfolio manager, Franklin Equity Group, weighs in on whether the state of the US economy can support further market gains, and whether US stocks may be getting a bit pricey. He says the two “pillars” of the US economy—consumers and corporates—still look solid.

We view current US economic fundamentals as strong, and characteristic of an economy that is still in a mid-cycle phase. Economic activity is picking up but inflation remains benign. Meanwhile, credit growth is strong, corporate profitability has been healthy and interest rates remain historically low and accommodative. Typically, this phase of the economic cycle creates a good backdrop for equities.

Much of the immediate post-presidential election optimism in the United States focused on the potential for pro-business policy proposals, including lower taxes and less regulation. Recently, investors have expressed some uncertainty surrounding the implementation of such policies, and have also been focused on politics abroad.

From an investment standpoint, we are hopeful for potentially positive changes to come, but prefer to focus on specific company fundamentals, the core economic backdrop, and bigger-picture secular growth trends.

Two Solid Pillars: Consumers and Corporates

What we see as the two main “pillars” of the US economy—consumers and corporates—still look solid to us and supportive of the market longer term.

On the consumer side, we’ve seen a few signs of softening data in recent weeks, namely in the area of retail sales. However, the overall leading indicators of consumer health remain strong and at high levels.

In March, consumer confidence reached its highest level since December 2000.1 The housing market has been improving, job growth remains strong, the unemployment rate continues to be very low and we are starting to see improved wage growth in many areas. Two of the biggest areas of job growth recently are manufacturing and construction, which had lagged since the 2007-2009 financial crisis.

In our view, the US consumer is healthy and should continue to be a driver of the economy going forward.

Turning to corporate America, we are just entering the first-quarter earnings season in the United States. Earnings results should provide evidence as to whether the post-election optimism of late last year has translated into tangible fundamental improvement this year.

To date, about a quarter of the S&P 500 companies have reported earnings, and we’ve seen the majority beating estimates for both earnings and sales. The current consensus estimate is for earnings to grow in excess of 9% in 2017.2 We think this level of growth should support the corporate side of the economy and provide a tailwind for the market.