It’s one year into the Trump Presidency, and it’s up in the air as to whether America is on a path to indeed be Great Again. Both the US economy and stock market have enjoyed the ride: although it is doubtful that the new President has driven much of this.
Mr Trump vowed to spend US$1 trillion ($1.3 trillion) on infrastructure: those plans have stalled. He promised to cut taxes: the House and the Senate have both introduced tax reform plans, with the proposal to lower the corporate tax rate from 35% to 20%, while for individuals, collapsing the existing tax brackets from seven to three, with tax rates of 12%, 25% and 35%.
Candidate Trump swore to repeal the Affordable Care Act, but that too has stalled: the House narrowly approved legislation to repeal and replace major parts of “Obamacare,” while the Senate failed to pass several repeal amendments. Likewise, the Border Wall with Mexico: Mr Trump ordered its construction, but he will need new legislation to pay for it. Last month the Wall was part of a list of immigration “principles” released by the White House, and eight prototype designs were unveiled, but the legislation for the Wall has not yet been introduced.
In fact, the increasing toxicity of Washington politics, while it retains the ability to discomfort the stock market occasionally – has almost become something markets can ignore, while they focus instead on the very real improvements bubbling up from the US economy.
Quite simply, the US economy looks to have entered its strongest growth phase for years. The rebound in job creation in October, which followed a hurricane-affected downturn in September, was subsequently revised upward. The US economy has now added jobs for 85 consecutive months, a record. The US unemployment rate fell to its lowest level in nearly 17 years in October, at 4.1%.
In the third-quarter of 2017, US gross domestic product (GDP) grew at 3% annual pace, beating forecasts of 2.5% annual growth, despite the economic effect of three damaging hurricanes that hit the country’s southern coast. Coming on the heels of the 3.1% annual growth rate in the June quarter it represented the first consecutive quarters of 3% economic growth since mid-2014. Business spending was strong, with non-residential fixed investment growing at a 3.9% annual rate in the third quarter. US home sales for September jumped sharply to the highest level in a decade, confounding expectations of a small decline.
During November, the Conference Board’s leading economic index (LEI), made up of ten components, across manufacturing jobs, unemployment insurance claims, manufacturing orders, building permits, credit demand, interest rates and consumers’ expectations of business conditions, returned a positive reading on all components. The Conference Board issued an “all clear, full speed ahead” signal for the US economy, into 2018.
In response to an improving economy, the US Federal Reserve announced in September that it would start to “normalise” its balance sheet, which had swelled from US$850 billion prior to the GFC to US$4.5 trillion, in the Fed’s quantitative easing (QE) stimulus response to the crisis. The end of QE also implies further interest rate rises.
The economic strength is flowing into US corporate earnings, which are on track to rise for a fifth straight quarter. And that has flowed into a stellar year so far for the stock market. Since Donald Trump was elected, the Dow Jones Industrial Average is up 23.6%, the broader S&P 500 has gained 17.5% and the technology-heavy Nasdaq Composite Index has surged 26.5%.
The US stock heavyweights, which are mostly global earners, are also benefiting from economic strength in Europe, China, India and most of the emerging markets. In fact, the world is enjoying synchronised economic growth, for the first time since 2008.
In particular, the US markets are being driven by the big tech stocks: the FAANG Group, short for Facebook, Apple, Amazon, Netflix, and Alphabet’s Google. If Microsoft is included – and no-one has yet come up with an appropriate acronym, you have the main drivers of the market. So far this year, the FAANG stocks plus Microsoft have accounted for one-quarter of the gains generated by the S&P 500 index. According to Bloomberg, US tech companies have added more than US$1 trillion ($1.3 trillion) in equity value this year.
The double-digit earnings gains across the market, and continued earnings strengths from the tech giants, have helped the US market rise through what seems a troubled geo-political backdrop, with escalating tensions on the Korean Peninsula, turmoil in Saudi Arabia, rising populism in Europe and China’s growing assertiveness.
With trailing stock price/earnings (P/E) ratios in the US market trading well above long-term averages, some investors, inevitably, are getting worried about US stock market valuations.
According to data provider FactSet, the trailing P/E ratio for the Standard & Poor’s 500 Index stands at about 22 times earnings: the five-year average is 18.2, and the 10-year average is 16.9. The forward P/E ratio for the S&P 500, which looks at expected future earnings, is about 18 times earnings, versus a five-year average of 15.7, and a 10-year average of 14.1.
But what may be worth factoring-in is that traditional measures of valuation, like the P/E ratio, find it difficult to pick up on the fact that many large companies are now driven by intellectual property (IP), not manufacturing. If it is IP and services that creates the value, the P/E as a concept may be misleading.
Technology is driving massive structural changes, with the use of robotics, artificial intelligence (AI), machine learning, big data, the Internet of Things, the blockchain and augmented reality. Analysts’ upgrades to earnings forecasts may only be starting to reflect this. And if it is technology, IT and ideas that are meaningfully increasing corporate earnings, the US market may not be over-valued at all, because comparisons with historical averages may no longer be valid.
Outlook for investors
The economy is showing enough momentum to grow above the post-GFC trend despite the US political backdrop. US shares are at record levels, buoyed by solid company profit numbers, strong employment data and the positive efforts of the Federal Reserve to manage the financial system and interest rate policies.
This is expected to flow into continued upward movement for the share market well into 2018. However, should the economy begin to ‘overheat’ and create upward pressure on inflation, an unwinding of growth could result caused by the flow on effect of a downturn in consumer spending, a tighter labour market, and in turn, lower company profits.
Information current as at 23 November 2017. This document has been created by Westpac Financial Services Limited (ABN 20 000 241 127, AFSL 233716). This This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material. Westpac Financial Services Limited and some of its related entities may have invested in the past, currently or in the future, in some of the companies referred to in this document. The content of this document is in no way a recommendation to invest in, hold or sell interests in the companies referred to. These projections are predictive in nature. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be affected by inaccurate assumptions or may not take into account known or unknown risks and uncertainties. The actual results actually achieved may differ materially from these projections. ©Westpac Financial Services Ltd 2017