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The Return of Normalcy?
U.S. MARKETS AND ECONOMY SHOW STRENGTH AGAINST UNCERTAIN BACKDROP
Going strictly by the news, very few would characterize what we've already seen of 2017 as a "normal" year.
From surprising overseas elections to domestic policy uncertainty and near-constant coverage of everything and anything related to the new administration, the macro backdrop received plenty of media attention. And if you were looking for the perfect social media hashtag, it would probably be "#uncertainty."
Policy uncertainty is often a headwind for economic growth, but it's served as a bullish influence on the stock market so far, offsetting sometimes excessively optimistic investor sentiment. And while political uncertainty doesn't seem to be going away anytime soon, a more normal investment environment may be emerging.
THE WEIGHT OF THE EVIDENCE
Concerns over the disappointing (relative to expectations) economic data we saw early in 2017 were overshadowed at the end of July when the government reported the economy's growth rate had more than doubled, from 1.2% to 2.6%. And although interest rates have increased twice this year, inflation is low. Stock valuations remain bearish, a notable risk in the current investment environment, but the broad range of stocks and sectors participating in the rally is encouraging. Other factors we watch when evaluating the Weight of the Evidence are neutral.
Looking ahead, we remain focused on three developing dynamics: continued tightening by the Fed, economic growth at home and abroad, and the overall breadth of stock participation in the now eight-year-old bull market.
THE WAY OF THE FED
According to their most recent projections, the Fed expects to increase rates by another 25 basis points in 2017 and continue a gradual path of policy normalization over the next two years. The deliberate pace of normalization so far has kept rates from becoming a headwind for stocks.
So far, the Fed has done a great job of telegraphing their intentions and guiding market expectations. If economic conditions continue to improve, we expect them to stay true to their announced plans.
SIGNS OF STRENGTH
The significant second quarter bump in the growth rate wasn't the first or only sign of improving economic strength this year. The labor market and consumer confidence have been strong as well. It's worth noting that disappointing economic growth has been a feature of this recovery for so long that growth forecasts have become less optimistic. The Fed's midyear forecasts assumed no significant acceleration this year or next. With such expectations, the opportunities for upside surprises like we saw in July become more significant.
The popular narrative that only a handful of stocks supported the rally early in 2017 never reflected reality. While the percentage of industry groups in uptrends waned, it never reached a troubling level, and the breadth of rally participation stayed generally strong. When the mega-cap Technology names that dominated the narrow-leadership theory seemed to stall, overall breadth actually improved and the percentage of industry groups in uptrends grew.
Broad participation isn't just a U.S. theme. Most global markets have been in rally mode in 2017. This is the mark of a strong bull market. For U.S. investors, the past few years have been a case where staying at home in terms of investments provided the best risk/return trade-off. The re-emergence of a more normal asset allocation environment in 2017 is a healthy development that we expect to continue.
Weight of the Evidence
The Fed is set to begin reducing its balance sheet, but additional rate hikes may depend on an uptick in inflation.
A global rebound in economic growth is finding renewed strength.
Earnings expectations for the third quarter are drifting lower, though at a slower pace than in recent quarters.
While market optimism has pulled back from recent extremes, it remains elevated by most measures.
Seasonal Patterns and Trends
A lack of volatility in the first half of the year could mitigate typical seasonal weakness.
The percentage of stocks in uptrends has deteriorated at the margin, but overall there remains bullish support for the stock market.
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