For the US, the second half of 2016 was a tale of two economies, with a robust domestic economy and weaker industrial sector. These tendencies are largely unchanged, however are actually set against a very completely different political backdrop. petroleum While the impact of Donald Trump’s election as US president stays unclear, the enhancing economic system must be supportive of US equities in 2017.
One economic system, two inflation ranges
Sturdy US shopper spending continues, with indicators showing encouraging information for areas comparable to retail, housing and auto gross sales. However, this sits alongside a comparatively lacklustre industrial sector, pushed by two factors:
1. Weak export development due to sluggish non-US financial activity and a powerful US greenback.
2. The collapse of the US energy sector, which followed the sharp decline in vitality costs.
This break up economic system subsequently led to completely different ranges of inflation in services and goods. As shown in the primary chart under, service prices (that are largely determined by home financial situations) have been rising round three%, whereas items prices (that are more a operate of global financial situations) have been flat or falling.
What this means for the Fed
The bifurcated nature of the US economic system offered the US Federal Reserve (Fed) with a problem: learn how to account for the fact that one half was growing at a charge higher than anticipated whereas the opposite was exhibiting the opposite pattern. In response, the Fed selected to lift curiosity rates in December, while its fee-setters forecast additional rises in 2017, contingent upon constructive incoming economic data. We anticipate, however, that if additional price rises do happen in 2017, these will likely be small and the ‘lower for longersituation will remain intact.
Strengthening macroeconomic situations
In a positive development, the 2 headwinds going through the industrial sector in 2016 have abated. Vitality prices have rebounded, bolstered by the agreement between OPEC and different oil-producing nations to cut oil manufacturing. At the same time, the US dollar has weakened since the start of the year. This should lead to the industrial sector posting stronger progress charges in 2017, and in flip allow overall US economic growth to reaccelerate to a fee of 2%-2.5%, which we noticed after the recession ended in mid-2009.
The Trump factor and policy uncertainty
The big change for the US has been within the political enviornment. President Trump’s bold proposed insurance policies have already affected markets in anticipation of their implementation, but a lot remains uncertain.
If Trump’s fiscal policies had been to be absolutely implemented, we may see stimulus reaching a degree of around 3% of GDP, which may be problematic within the longer time period. US unemployment is now under 5%, which is what most economists consider to be the economy’s pure rate. As the unemployment price has moved additional below 5%, wage progress has accelerated in a typical approach. In past cycles, wage development has accelerated each time the unemployment price has fallen beneath 4%. If the economy does three certainly reach the 2%-2.5% progress charge, and there is an additional 1%-1.5% of further stimulus in 2017, the unemployment charge would seemingly proceed to fall further, triggering a further acceleration in wage progress. This might lead to a stronger economy in 2017 as shoppers profit from wage progress, however it may also trigger the Fed to reply extra aggressively than what the markets have presently priced in, by elevating curiosity charges higher and quicker.
Greater US curiosity rates would possible result in increased bond yields, albeit inside limits. Regardless of rising since the election, real yields have remained very low, at just above zero. This seems inconsistent with an anticipated economic development rate of two%-2.5% plus additional stimulus. These low yields are possible a by-product of policies implemented by different central banks all over the world. Quantitative easing, by which central banks create money to buy bonds, has directed huge volumes of money to the US Treasury market, driving bond costs increased and yields lower. Whereas the US may have ceased its bond-buying programme, different markets, together with the EU, have continued theirs. So while we are able to count on higher US Treasury yields, there’ll in all probability be a restrict to how high they go, making them unlikely to pose a risk to the economic exercise of 2017.
The costs of economic stimulus
Earlier than the presidential election, the Congressional Funds Office had forecast that the federal debt-to-GDP ratio would improve over the following decade, reaching round eighty% by 20251. Nevertheless, if Trump’s proposals had been fully applied, that ratio would exceed a hundred% during that period2, reaching the same levels as in nations affected by the European debt crisis Petroleum Refinery Equipment Project Performance countries. If the growth in US debt continues alongside this trajectory, considerations about debt sustainability could improve over the following decade. This, coupled with a less favourable supply-and-demand balance within the Treasury market, could ultimately put upward stress on yields. However, these are potential areas of concern that may have an impact beyond 2017.
The other key area of concern for the US economic system is Trump’s insurance policies on commerce. There are currently trillions of dollars of goods that move into and out of the US economic system on an annual foundation. Ought to significant tariffs on imports be levied, US consumers would lose purchasing energy, whereas other international locations could implement tariffs in retaliation. The result could be a lot increased costs for US customers and so decreased shopper spending, as well as dampened export progress. Finally, there are properly-entrenched global provide chains that rely on the relatively free motion of goods between international locations. To disrupt these supply chains would no doubt have a unfavourable affect on financial exercise. Once more, nonetheless, none of these outcomes are likely to play out in 2017, but relatively in 2019 or 2020.
Life like expectations
There are vital obstacles that President Trump must face ought to he push for his full proposed stimulus and policies. Firstly, most of the policies would require congressional approval, which isn’t guaranteed. Even in the event that they were accredited, it could then take time to implement them. For instance, a big infrastructure spending package would take a major period of time to execute as initiatives should be identified and resources mobilised. The same goes for commerce insurance policies.
A supportive backdrop for US equities stays regardless of uncertainties
The US equity market presently appears absolutely valued, with the price-to-earnings ratio at a degree that has hardly ever been exceeded. Because of this, we imagine an affordable expectation is for total return over the next 12 to 18 months to be pushed by a combination of earnings development and dividend yield.
Fortunately, with an economy that is improving, an industrial sector that’s recovering and the possibility of corporate tax cuts, the outlook for US earnings is optimistic. In our view, it’s also cheap to count on stable earnings development over the subsequent 12 to 18 months and, if you happen to consider dividend yield on prime of that, there is the potential for optimistic equity market returns as we undergo 2017 and into 2018.