January 2017 Monthly Outlook
The first estimate for real gross domestic product (GDP) increased at a rate of 1.9% in the fourth quarter of 2016. Based on this estimate, real GDP increased 1.6% for the year as a whole. This growth rate is in line with the average rate of 2% that we’ve seen since the 2009 recession. Growth continues to tread along at a moderate pace that's strong enough to keep a new recession at bay, but has not repaired all the damage that lingers from the last downturn. The first quarter of 2017 looks to be stronger economically than the past few years, with the Atlanta Fed now estimating a GDP of 3.4%.
The Conference Board Leading Economic Index® (LEI) for the U.S. was increased by 0.5 in December to 124.6, suggesting the economy will continue growing at “a moderate pace, perhaps even accelerating slightly in the early months of this year,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “December’s large gain was mainly driven by improving sentiment about the outlook and suggests the business cycle still showed strong momentum in the final months of 2016.” The continued strength in the economy has caused inflation to reach a multi-year high of 2.1% meeting the Federal Reserve’s inflation targets. This has caused the Federal Reserve to indicate that they expect to raise short term interest rates three times in 2017.
Indicators point to the U.S. economy continuing to grow slowly (~2% annually) and being in the late stages of a long business up-cycle without major excesses that brought down some prior economic upturns. There seems to be hope that the economy can grow faster than 2% annually if government regulations and taxes are eased.
Bond and Stock Market Commentary:
U.S. stocks got off to a solid start in 2017 with the S&P 500 Large Cap index increasing 1.79% in January, as corporate earnings season is in full swing and has been in line with expectations thus far. Over the longer term, stocks will move based on their earnings growth. Interest rates were stable in January, which caused bonds and real estate to increase slightly to account for the fixed income that accrues on these investments.
There was an excess of media noise in January that provided interesting headlines but does not have any real impact on the stock market. The predominant example was the excitement around the Dow Jones Industrial index reaching 20,000. While this news received widespread attention, it is virtually meaningless to financial professionals and causes no change to how portfolios are managed.
The DJIA is a price weighted index comprised of only forty stocks. These forty stocks are weighted based their stock price, so a higher priced stock has a higher weighting in the index than a lower priced stock. A stock’s price is a function of the amount of shares a company issues. Therefore, a company that has fewer shares issued will typically have a higher stock price. Therefore, higher priced stocks like Goldman Sachs disproportionately cause the index to increase. Additionally, the DJIA only includes 40 companies compared to the tens of thousands of publicly traded companies in the U.S. Professional investors most closely watch the S&P 500 index because it is made up of 500 companies weighted by the size of the companies. This means a large company like Apple has a larger weight in the index than a smaller company, so the index provides a truer picture of what’s happening broadly across the stock market.
While there are various other examples of media noise, it’s important to consider the impact these events actually have on the stock market. Historically, these events can create an initial increase/decline but quickly reverse to show no real impact. In January, there was no shortage of political noise surrounding the new administration, but the specific actions taken thus far should have no effect on the economy or stock market.