Great Expectations

January 3—After getting off to a very poor start—the Dow Jones Industrial Average lost 6.2% in the first five trading days of 2016—stocks overall finished the year well into the black. This was not an outcome that many experts saw coming. Most predicted severe negative economic repercussions when British voters chose to leave the European Union in the Brexit vote. Similarly, some saw the election of Donald Trump as most likely to throw the financial markets into uncertainty, if not panic. The opposite has happened.

Most of the growth in stock prices occurred in the second half of the year, with the DJIA gaining 8% just since election day. Apparently, investors are optimistic that a Trump administration will provide sufficient regulatory and tax relief, coupled with new infrastructure spending, to boost GDP growth above the 3% mark in the coming year, a level not seen in many years.

Consumers have shared the surge in confidence. The Conference Board reported in December that its index of consumer confidence jumped from 109.4 in November to 113.7 in December. That’s the highest level for this indicator since August 2001, when it stood at 114.

Can the optimism be sustained? In part, that will depend upon how well a President Trump is able to deliver the promises made during the Presidential campaign. Also important for stock prices will be the corporate earnings reports. Earnings for the companies in the S&P 500 grew 3.1% in the third quarter of the year from the year-earlier period, and they are estimated to be up 3.2% for the fourth quarter. Solid earnings reports will be needed to justify the current price/earnings ratios of many stocks.

Housing

Nobel laureate Robert Shiller, co-creator of the Case-Shiller housing index, is not quite ready to forecast a boom in housing, where the growth in prices has remained steady at about 5%. But he does suggest that change could be coming. Shiller told Bloomberg News in December that “I think we’re at a turning point. The numbers that we’re reporting today are October, before the Trump election, and everything looks different now. There might be a Trump boom coming.”

Interest Rates

Rising interest rates could put a damper on those rising home prices, despite optimism about the economy generally. The Federal Reserve Board raised short-term rates a quarter-point in December, a move that had been expected earlier in the year. Should the economy demonstrate more robust growth, the Fed may be expected to nudge interest rates back to their normal range. This will be seen as great news by savers and investors, many of whom have suffered during the prolonged interest rate drought.

But rising interest rates will pose a dilemma for the new Trump administration. As rates go up, so does the cost of servicing the national debt. Those increased costs may crowd out hopes for new spending or dramatic tax cuts. At the least, they could make political compromises more difficult.

It looks like 2017 will be a very interesting year.

© 2017 M.A. Co.  All rights reserved.

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