Investor Confidence in Economic Growth Is Rising

Key Points

• Investors continue to digest the results of Trump’s election, with most focusing on prospects for a pro-growth agenda.
• Equity markets have been rallying, but some areas clearly look more favorable than others.
• Yields will likely continue rising, putting additional pressure on government bonds.

Investors continued to focus on the possibility of corporate tax cuts, infrastructure spending and deregulation that could come with a Donald Trump presidency. These factors could accelerate both economic growth and inflation. In light of these prospects, investors broadly moved from bonds to stocks last week, causing yields to rise and equity prices to increase.1 The S&P 500 Index rose 0.9% last week.1 Telecommunications and financials led the rally, while health care and consumer staples lagged.1

 The Equity Backdrop May Favor Active Management

Equity price correlations have fallen since the election.2 Previously, equity correlations rose in the aftermath of global shocks such as China’s currency devaluation, plunging oil prices and Brexit.2 The opposite is happening now, as sectors and individual securities show clear distinctions between winners and losers. In particular, pro-cyclical sectors have outperformed while defensive areas have lagged.1 In addition, rising bond yields hurt income-oriented areas of the market while helping financials.1 We expect these trends will persist given the political, economic and earnings environment. Additionally, we believe these falling correlations could provide a boost for active managers who focus on stock selection.

Weekly Top Themes

1. Two key data points point to stronger economic growth. October retail sales rose 0.8% versus an expected 0.6%.3 Also, weekly jobless claims fell to 235,000, the lowest level since 1973.4
2. A possible trade war would likely be negative for global economic growth. Investors have not yet focused on the prospects for greater trade restrictions and increased tariffs that could come under Trump’s presidency. Should these developments emerge, the results would likely be a drag for multinationals, although domestically-focused companies could see a relative benefit.
3. We expect upward pressure on government bond yields to continue. The sharp yield spike that occurred over the past two weeks may consolidate in the near term, but accelerating growth and inflation will likely be negatives for government bond prices.
4. The likelihood of corporate tax cuts is providing a tailwind for stock prices. Higher after-tax earnings would allow corporations to engage in a variety of shareholder-friendly activities.

Equities Should Overcome Risks of Rising Rates

The post-election environment remains dominated by uncertainty. However, investors generally appear cautiously optimistic about President-elect Trump’s likely policies. The fact that Donald Trump has appointed some establishment Republicans and reached out to House Speaker Paul Ryan seems to have calmed some nerves. That could change if Trump ramps up his anti-trade or antiimmigration rhetoric, but for now investors remain focused on the prospects for a pro-growth agenda.

As investors gain confidence about the direction of the economy, concerns are rising that monetary conditions could tighten too quickly, which could undermine growth. These fears are compounded by the spike in global government bond yields, a rising U.S. dollar and widening high yield spreads.1 If these trends persist and accelerate, they could hamper growth and risk asset prices. However, consider that the fed funds rate remains historically low, the 10-year Treasury yield has merely returned to levels seen at the beginning of 2016 and high yield spread movement has been quite modest.1

So far, equity markets have not been troubled by the rise in bond yields or the dollar. At the same time, investors have largely looked past the recent slide in oil prices. These developments could present some risks, but we expect positive global economic trends and improvements in corporate earnings to outweigh the potential negatives. As such, we maintain a pro-growth investment stance and favor equities over bonds and credit sectors within fixed income.

Bob Doll Weekly Commentary