Economic Commentary | Fourth Quarter 2016

The markets were mixed during the quarter ~ domestic indices rallied while global markets gave up some of their earlier gains. For the three months ending December 31st, the large cap S&P 500 index increased 3.8%, the mid/small cap Russell 2000 index gained 8.8%, and the international MSCI EAFE index declined by 0.7%.

The dominant news story of the quarter was the surprising election of Donald Trump to be our next president. Contrary to expectations prior to November 8th, the markets surged on Trump’s win, as investors collectively focused on expectations of a more business-friendly regulatory environment, large tax cuts, and a $1 trillion spending package for the country’s infrastructure. In the ensuing weeks, domestic stock market indices hit new record levels with some frequency. In fact, the S&P 500 index hit a total of eight new record highs in the remaining seven weeks of 2016 after the election.

Oil prices firmed after OPEC finally reached a deal in late November to cut production by 1.2M barrels per day. In early December, non-OPEC members agreed to follow suit on OPEC’s production cut, further supporting higher crude prices. WTI crude gained 11.4% during the quarter and closed at a healthy $53.72/barrel. This level strengthens the economic prospects for US domestic oil producers who are not involved in OPEC production cut agreements but represent an increasingly significant portion of world oil supply.

We are pleased to report that the US economy has exhibited broad strength in recent months:

  • consumer confidence hit a level in December not seen in 15 years;
  • GDP gained 3.5% annualized for Third Quarter (reported during Fourth Quarter);
  • home prices continue to rise (important since this is most people’s single largest asset);
  • the labor market created more than 2M jobs for the third straight year; and
  • wages are improving with a gain of 2.9% reported in the final jobs report of the year.

To further buoy this good news for consumers, businesses are finally gaining confidence, which is the last piece of the economy to fall into place and which augurs well for improved capital investment by corporations. There is no doubt that anticipation of Trump’s pro-business policies is contributing to this improved sentiment.

The Federal Reserve hiked rates only once in 2016, adding a quarter point to the target rate at its meeting on December 14th. This move was largely expected, but what was also revealed in the Fed’s statement was a forecast of three rate hikes in 2017. Given the Fed’s dual mandate of full employment and stable prices, it is timely that we will be seeing a reduction in monetary stimulus over the course of 2017.

We also received good news from abroad this quarter. The Eurozone’s third quarter GDP grew by 1.7% year-over-year, which was modestly better than expectations. China, too, kept forging ahead, growing an annualized 6.7% in third quarter, which put the Chinese economy firmly on track to meet its 2016 growth goal of 6.5% to 7.0%. Retail sales and industrial production bested expectations while China’s manufacturing and service sectors gained strength. This stabilization of the world’s second largest economy is further boosting global economic sentiment.

In a sea of largely positive news, we see two risks to the US economy in the near-term, both of which relate to global trade: 1) the strength of the dollar, which gained more than 7% during the quarter to end at its highest level in 14 years, as a strong currency makes our exporters’ goods more expensive to global buyers, and 2) Donald Trump’s desire to abandon existing trade deals in favor of bilateral agreements, which could hurt our trade balance if the US becomes more protectionist. It’s uncertain whether the US under Trump will participate in the Trans-Pacific Partnership, which includes 11 other nations and addresses trade representing 40% of the world’s economy. As foreign policy represents one of only a few areas where the president has significant unilateral influence, we are left to wonder whether the President-elect will fulfill his promises with all of the enthusiasm he displayed on the campaign trail or whether a more moderate Trump will emerge once he is inaugurated as our 45th president.

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