The market’s ascent in the first quarter continued a trend that began shortly after the November 2016 election. Market participants seem to be expecting the implementation of new economic policies designed to produce an increased rate of growth for corporate profits as well as the overall economy. The new favored policies are likely to include a lowering of tax rates on corporate profits, and a streamlining of regulations, as well as an overall reduction in tax rates.
At almost the time the election was taking place, economists were revising upward their forecasts for real economic growth for the next twelve months. Measures of economic activity in the short term have been mostly consistent with the revised expectations. As an example, on a year-over-year basis industrial production has demonstrated a gradual increase beginning in the fourth quarter of 2016. The combination of upward revisions in the forecast for economic growth, and the outcome of the election has helped to push the overall market to record highs, and moved the market’s valuation to the upper end of its long term range.
To sustain valuations at current levels, the market’s expectations with respect to economic growth and economic policies must be met. Unfortunately, there may be impediments to the realization of those expectations. While economic activity has shown some signs of improvement, the Fed has indicated it will raise short term rates further in 2017. The market has accepted a consensus forecast for as many as three rate increases in 2017.
As 2017 progresses, both the direction of the stock market and the robustness of economic growth will be shaped by changes in monetary and fiscal policies to a greater degree than in the previous few years. There is no clear path for the implementation of any changes in policy, and therefore, it is best for investors to remain patient and seek holdings in reasonably valued stocks of companies that are experiencing positive revisions on earnings and revenue estimates as well as enjoying relatively strong price action.