Economic strength appears sustainable
- A consistently solid U.S. economy helped propel the post-election equity rally through most of the first quarter of 2017. The economic outlook suggests continuing global improvement.
- The dollar has cooled but still has room to run; currency trends tend to persist. U.S. earnings growth remains above average and is projected to improve. Economic indicators are consistent with 3% GDP growth.
- Expectations for Trump fiscal policy are elevated. If policy disappoints, investor sentiment could turn negative. If results are too successful, there could be unintended consequences.
Value-style stocks typically outperform when the economy accelerates
- U.S. stock valuations are close to longer-term historical averages, neither cheap nor excessively expensive.
- The most expensive quintile of stocks — led by large-cap growth stocks — now carries an average valuation more than twice as high as the remaining 80% of the market.
- Value outperformed in 2016, and faster GDP growth historically benefits cyclical value sectors such as financials and energy.
- Small-cap outperformance may be driven by stronger earnings and benefit from fiscal stimulus.
The Fed is tightening rates at a slow but steady pace
- With three rate hikes expected over 2017, the Fed views the outlook as uncertain and will be data dependent, adjusting its stance as visibility improves.
- If history is any guide, this cycle of higher interest rates has further to go.
- Rising rate cycles are historically positive for equities.
- Diversifying with non-traditional fixed-income investments can help mitigate interest-rate risk.