Commentary | Q4 2017

December 2017

The market began a rapid move upward right after the Presidential Election of 2016 and the trajectory continued throughout 2017. At the end of 2017, most stock market indexes were at or near all-time highs. The market was buoyed by expectations of a reduction in tax rates, a reduction in regulations, little or no change in monetary policy, a 2.5% to 3.0% growth in real GDP, and rising corporate profits. The changes in regulatory policies and the lowering of tax rates, which occurred throughout the year, were expected to provide a foundation for real economic growth to continue in 2018.

At the end of 2017, the S&P Index was selling at a price earnings multiple on forward earnings of approximately 18.4. This is above the average of 14.2 for the last ten years. The relatively high valuation for stock prices reflects optimism with respect to economic growth and an increase in corporate profits in the coming year. Real growth is expected to fall in a range of 2.5% to 3.0%, and corporate profits are expected increase at a rate of more than 11%. Whether or not these expectations are realized will be determined by the course of future economic policies.

A general lowering of tax rates has been put in place and should provide some stimulus for economic growth. However, the consequences of this change in policy may develop within an uncertain time period, as has been the case in the past when such policy changes were implemented. While some of the rate reductions are set to become effective immediately, other rate reductions are set to take place in the future. The delay in rate reductions tends to slow down economic activity, in much the same way an announcement of a 30% reduction in car prices beginning the day after tomorrow would slow down car sales tomorrow.

While fiscal policy is reasonably well defined for 2018, monetary policy remains uncertain. The Fed has raised its target range for the federal funds rate five times since December 2015 in order to normalize monetary policy, and is projecting three more increases in 2018. However, over the past twelve months, while the Fed has increased short-term rates, the rate of growth of the money supply has actually increased. In addition, inflation (as measured by the annual change in price index for personal consumption expenditures excluding food and energy) has fallen short of the Fed’s 2% target despite a steady drop in the unemployment rate to 4.1%. In 2018, the Fed faces a delicate balancing act between normalizing monetary policy while promoting the twin mandates of maximum employment and price stability.