BY ERIC STURDZA
In March, investors were focused on (1) the FOMC minutes, (2) economic data releases, (3) the upcoming earnings season, and (4) the “Trump trade”.
(1) The Minutes from the March policy meeting were released with no particular surprises. Some members did see upside risks from fiscal policy, but there was no surprise here either as the Fed’s primary focus is the labor market and not GDP growth, due to potential impacts on the labor market (and as such the general growth outlook) that could stem from trade or immigration policy changes. Additionally, some officials “viewed equity prices as quite high relative to standard valuation measures” which, for the Investment Adviser, simply signals that the market will at some point revert toward companies that offer superior growth at similar or lower valuations.
(2) On the data front, the employment report was a mixed bag and was consistent with signs of softness in consumer spending. Nonfarm payrolls rose by 98,000, below the median forecast of 180,000. So for the first quarter the average monthly gain was 178,000, in line with 2016 average. The unemployment rate went down to 4.5% (keep in mind the +/-0.2% error here) and labor force participation was unchanged (practically flat over 1 year). Even though the data has recently been softer, job and wage growth are still supportive, but gasoline prices have been rising. One must keep in mind that while nominal average hourly earnings rose by nearly 3% on a YOY basis the inflation adjusted figure is standing at 0%. However, weather and seasonal adjustments can, and often do distort the picture and the fundamentals remain sound. Job and consumer data will be increasingly important trends to follow over the next few months.
(3) Consensus expectations for the upcoming S&P 500 earnings season are up by nearly 7% YOY, with energy playing a dominant role in the projected earnings growth rate. Even though these expectations continue the positive trend that began in the 3rd quarter of 2016, the strongest growth rate in years, the Investment Adviser is cautious. Investors have been very harsh with results over the past quarters. Companies that meet or beat estimates were generally not rewarded with any substantial price appreciation whilst those who disappointed on just one metric were punished.
(4) After the election the stock market rallied on the expectation that looser regulations, infrastructure spending and tax cuts would boost the economy. The Trump non-believers highlighted two fronts that warrant caution. The first, which seems to be shared by the Fed whose median GDP growth forecast stands at 2.1% for 2017 and 2018, is that labor market constraints will likely hold back growth (demographics). The second reason is simply the difficulty that lies behind achieving such an agenda. A rollback in regulation is very plausible as it doesn’t require Congress to rewrite regulations. The infrastructure spending program ($1 trillion) is harder to implement as legislation will be difficult to get through the House. Tax reform is even harder as it would need 60 votes in the Senate (of which 8 must come from Democrats). Budget reconciliation could be another way for Republicans to achieve tax reform (as only 51 votes would be required in the Senate) but it is already being utilised for the Affordable Care Act (ACA) repeal. Additionally, there are many tax issues already embedded in the ACA, which is why the Republicans had to get the repeal done before they could start with tax reform. Decreasing business taxes would decrease revenues, which is why a Border Tax Adjustment was put forward as it would offset half of the decrease in revenues; but this approach has up to now been met with a lot of skepticism. Therefore, if the rally since the election has only been based on Trump and his agenda (which the Investment Adviser does not believe is the case) there will be a serious disappointment. Investors have already grown more skeptical on Washington’s ability to get this done since the ACA repeal failed. On the other hand, if the stock market rally is based on other factors (which is what the Investment Adviser believes) investors might not see much of a drawdown and the stock market should eventually become more selective.
The Fund underperformed its benchmark in March and now stands at +6.02% against 6.08% for the MSCI US TR on a year-to-date basis.
The views and statements contained herein are those of the Eric Sturdza Banking Group in their capacity as Investment Advisers to the Fund as of 19/04/2017 and are based on internal research and modelling.