What are the top two questions clients are asking after the Presidential election?By: Ryan Fulmer
Tuesday, December 13, 2016
Will the Presidential election affect the trajectory of interest rates?
Since Donald Trump has been elected, the ten-year Treasury yield has increased from 1.88% to 2.36% (or a price change from 129.70 to 125.25). The bond market sell-off is likely due to investors perceiving the President-elect’s policies being more favorable for economic growth, the likely selection of a new Federal Reserve Chairman in mid-2017, and more government spending.
The stock market has risen 3.6%, with pundits highlighting Trump’s potential efforts to deregulate industries, reduce taxes, and complete a massive infrastructure program. It is anyone’s guess how these policies will look once (or if) enacted, but economists have estimated that these policies will accelerate economic growth in the U.S. by about three-quarters of one percent (or 75bps) starting in the middle of 2017. Domestic growth has been trending around 2% per year, and any increase would clearly be a positive for the economy and ultimately the stock market.
As Chairwoman Yellen’s term will expire in early 2018, President-elect Trump will need to select a new Federal Reserve leader in the middle of 2017. The Republican-led House of Representatives will likely push the President-elect to select a more hawkish individual that will want to raise interest rates at a faster pace than Janet Yellen due to the low unemployment rate and signs of increasing inflation.
Expectations set by the Federal Reserve’s ‘dot plot’ forecast show interest rates slightly above 1% by year-end 2017 and almost 2% by 2018. It is highly anticipated that the Federal Funds Rate will increase by one-quarter of a percent in December.
How will the stock market perform in 2017?
Our crystal ball stopped working after the election! All kidding aside, when we forecast future-year returns, we look at the following: S&P 500 year-over-year earnings growth, current price-to-earnings (P/E) ratios, and the general level of interest rates. Within these broader assumptions there are many other variables, such as sales growth, gross margin and profit margin estimates, etc.
In 2017, reported earnings growth will be around 10-12%, driven by the Materials Sector (steel, aluminum, and other commodities), Financials (banks and insurance companies), and Technology.
Stock prices go up or down because of a combination of higher/lower earnings or higher/lower price-to-earnings multiples. At this point it looks reasonable to believe earnings will increase high single digits, but price-to-earnings multiples are unlikely to increase due to rising interest rates.
Rising interest rates result in more competition for investor’s capital. I expect interest rates to remain low for the next couple years, keeping investors in stocks. As interest rates creep back to normal (or 3-4%), price-to-earnings multiples will likely decline back to average levels.
Let’s do some quick math to look at the stock market upside and downside based on current market projections. If the S&P 500 Index is currently around 2,200 and earnings will be $105 in 2016, that equals a price-to-earnings multiple of 21 times. Earnings in 2017 of $116 per share at 21 times suggests the S&P 500 will rise to 2,444 (or about 10% more)!
Don’t get too excited.
With interest rates rising, investors aren’t going to pay 21x earnings, but the market has been around 19x, which estimates the stock market would end 2017 around the current level of 2,200.
This doesn’t paint a very good picture for 2017, but the stock market is always looking forward and anticipating future events. Some Wall Street strategists estimate that a 1% increase in U.S. GDP would improve 2017’s earnings per share by $5. With similar math as above, it would put the S&P 500 at around 2,294 (or about 4% higher than current levels).
It looks like the stock market may be getting a little ahead of itself and, as we have written in the past, the first year of the Presidential cycle is usually volatile, with either double-digit increases or decreases.
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits and has been ranked as one of the largest money managers in Northeast Ohio.
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