Despite demonstrated challenges carrying out key campaign promises, optimism surrounding President Trump continued to buoy equity markets during the first quarter. All three major U.S. stock indexes ended higher, with the S&P 500® up 5.53% (its biggest quarterly increase in over three years), the Dow Jones up 4.56% and NASDAQ up 9.82%. The markets appear to have priced in a comprehensive slate of pro-growth policies from the Trump administration and aren’t yet losing confidence in the President’s businesslike but often chaotic approach to governing. However, much uncertainty remains as we progress through the year, and investor patience will not persist indefinitely.
The first attempt by Republicans to repeal and replace the Affordable Care Act (“Obamacare”) failed to gain traction in Congress. With insufficient support in the House, the health care reform bill was officially withdrawn without being put to a vote. While the President has redirected his focus to other campaign promises such as the highly anticipated tax reform bill, health care remains an important issue and discussions amongst policymakers are ongoing. Due to the sheer size and complexity of America’s health care system, the administration will likely face continued headwinds from Republicans and Democrats alike, with the right wanting larger spending cuts and the left looking to preserve many of the current law’s existing provisions. Importantly, it remains to be seen if the failure of his initial health care reform bill will create a loss of momentum for President Trump that will hinder his ability to push forward other legislative priorities.
At its March meeting, the Federal Reserve raised the Federal Funds rate by 0.25%. The new target for Fed Funds is 0.75% to 1.00%. Barring significant changes to the pace of growth in the U.S. economy, the Fed remains committed to gradually raising rates over the next couple of years, with two additional increases projected in 2017 and another three increases in 2018. There remain questions, however, about when the Fed will begin taking steps to reduce its $4.5 trillion balance sheet. The likely first step in this process is ending the reinvestment of maturing Treasury and mortgage-related securities. While Fed Chairwoman Janet Yellen has not indicated any sense of urgency, there is a real possibility that the process could begin before the end of the year. Since we’ve never encountered such a scenario, it’s uncertain how the markets will react to the unwinding of the massive Quantitative Easing (QE) deployed by the Fed over the past several years.
In international news, Great Britain sent a letter to the European Union on March 29 to officially trigger Article 50 of the Lisbon Treaty. This letter, signed by UK Prime Minister Theresa May and hand-delivered to the President of the European Council, starts the formal process of ending Britain’s 44-year membership in the EU. The UK and the EU now have two years to negotiate new rules for everything from labor and trade to education and health care to immigration and expatriates. These negotiations promise to be protracted and wrought with complications for both parties. Regardless of the status of the negotiations, though, Britain will formally cease to be part of the EU in March 2019. This situation, coupled with this year’s upcoming elections in France and Germany, creates additional uncertainty for investors over the near term.
On March 21, the market ended its run of 109 straight trading days without a pullback of greater than 1% — the ninth-longest streak in history. This selloff may be the first sign of skepticism in the President’s ability to push legislation through what should be a very accommodative Republican-controlled Congress. In addition, the first quarter of 2017 was the S&P 500’s least volatile quarter since 1967. This may demonstrate a sense of complacency that could make the market more susceptible to a downturn in the event of a negative economic or market occurrence.
A loss of momentum is starting to be reflected in financial markets. After the health care reform debacle, how will the markets respond if things don’t go as expected? Can the markets absorb a second major policy disappointment (e.g., tax reform) from the White House? Earnings growth expectations are the highest they’ve been since 2011, consumer confidence is at its highest level since December 2000, and bullish investor sentiment hit a 30-year high in March. In spite of this, GDP growth is projected to remain very low, with the Atlanta Fed estimating first quarter growth at just 0.90%. As the bull market and economic expansion enter their ninth year, we struggle to see how current market fundamentals will support continued market increases. While there are signals that a correction could occur — which we think would be healthy for the market — we do not believe this is the precursor to a recession. We will be watching this closely as the year progresses. Long-term investors should stay the course, while those nearing retirement may want to re-evaluate their asset allocations to ensure appropriateness. As always, we do not recommend trying to time the market.
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