A Glass Half Full

Tab 1

June 19, 2017

The winds of political change that blew through the United Kingdom and United States last year apparently have left investors wondering: What else could possibly be in store for the global economy and markets this year?


In the United States, market participants are deciding how much of the recent rally in riskier asset classes is due to the new administration and how much is grounded on improving global growth. Investors have shifted their focus from the U.S. Federal Reserve’s monetary policy agenda to the new administration’s legislative agenda. The recent healthcare debate that ultimately culminated in deferred action but muted market reaction suggests that markets are not completely dependent on new legislation to drive investment gains.


In Continental Europe, a spreading wave of populist sentiment may have a significant impact on the markets, with a key German election looming later this year.


Overall, U.S. Bank views investment markets as a glass half full, with positive returns for equities, a difficult bond environment and varied returns for alternative assets.

Equities Still Appear Attractive


While equity securities are subject to market fluctuation due to economic and business developments, the equities markets raced forward after the November elections. Some question if these markets got ahead of themselves.


Robert Haworth, Senior Investment Strategist for U.S. Bank Wealth Management, doesn’t believe so, “as long as some of what they anticipate comes to fruition, such as corporate tax cuts and a reduction in regulation.”

Tab 2

June 19, 2017

“Though U.S. equity markets are at record highs and valuations feel rich due to some metrics, domestic stocks are still attractive relative to bonds,” says Eric Freedman, Chief Investment Officer for U.S. Bank Wealth Management. He sees opportunity in foreign equities in developed markets aided by “valuation support, central bank policy accommodation and improved consumer and business activity.” Yet, he notes that his team is focused on political risks related to the European wave of populist sentiment.


The emerging market equities outlook is cloudier, as some countries face currency risks due to a strong dollar.


“Emerging markets are idiosyncratic, with differentiation by country and region,” he says. "Many emerging market companies have bonds issued in dollars, so a move higher in the dollar can be costly. On balance, we see improving underlying economic fundamentals, but currency and commodity movements can confound the picture.”

Can Small-Cap Outperformance Continue?


The rally in stocks this year has been led by small-cap equities. “Some of that was catch-up after underperforming in the prior two years,” Freedman says.


One would expect small- and mid-cap stocks to do well given their relative lack of currency exposure and greater domestic focus, which can buffer them from the impact of a stronger U.S. dollar. But Freedman says those recent gains cast doubt on the sustainability of that edge.


Growth Sector Opportunities


Growth-oriented sectors such as technology, healthcare and industries supported by discretionary income could continue to outperform the market and may benefit from higher inflation, rising earnings growth and decreased regulations. U.S. Bank strategists believe these have attractive valuations and long-term growth potential. Yet Haworth notes not all growth sectors are positive, as financials and energy might be ahead of themselves.

Tab 3

June 19, 2017

What About Bonds?


With continued interest rate hikes likely, the bond outlook is fairly subdued, although the Fed likely understands the risks of improperly signaling their intentions. If the Fed raises interest rates too quickly, borrowing costs could rise faster than the still fragile economy can withstand. U.S. Bank does not expect a rapid increase in longer-maturity interest rates, but the push-pull of intermediate-term interest rates will likely leave the bond market stuck in low return mode for the immediate future.


Eyes on Inflation


Assuming the U.S. economy continues to grow, U.S. Bank strategists believe the Fed could raise short-term interest rates two or three times in 2017. But while inflation held at around 2 percent in 2016, the Fed could aggressively raise rates if inflation increases, Haworth says.


Rising U.S. interest rates tend to strengthen the dollar. Haworth recognizes that a stronger dollar could eat into U.S. exporters’ profits and slow growth, making it less likely the Fed will raise rates quickly.




Economic and Political Concerns


U.S. Bank’s key concerns as to how global economic and political trends and events may impact markets include:

  • Populist sentiment in Europe creating elevated market uncertainty
  • This fall’s National Congress of the Communist Party of China to determine party leadership and the government’s political and economic policy
  • The impact of emerging policies under President Trump
  • Recovering commodity prices, especially in the oil market and mining1; renewed raw material consumption in China (which holds one-sixth of the world’s population); and an anticipated economic turnaround in Brazil and Russia


Trump Policies to be Felt Over Time


“The Trump administration’s policies may be good for growth if they are executed,” says Dan Clifton, Partner and Head of Policy Research at Strategas Research Partners. “Fiscal and regulatory policy would move in the right direction. Trade may be a slight negative but may not be as bad as anticipated.”

Tab 4

June 19, 2017

“The two major legislative pieces that capital markets are focused on remain taxes and healthcare,” Freedman says. “Changes to both could be perceived as pro-growth, but perhaps the greater significance is that change would require more of a consensus in Congress than we saw with the first healthcare bill under the Trump administration. Should either tax or healthcare reform emerge, that could pave the way for additional legislative activity, particularly ahead of midterm elections.”


A Positive View


Overall, a half-full glass presents roadblocks — but there may be opportunities for savvy investors. 

“This climate is where our role in making asset-class decisions and finding global opportunities is especially important for our clients — particularly at the sub-asset class level of stocks, bonds and alternatives,” Freedman says.


1 Risks associated with commodities include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Alternative investments are designed for investors who can tolerate a full investment loss and are not suitable for everyone, even if an investor meets the financial requirements.  

Markets & Economy