As we move into the second half of 2017, we find ourselves in a familiar place. Once again, as in 2016, we saw a weak first quarter and rising concerns that the economy was rolling over. And once again, we have seen stronger data in the second quarter, which should lead to another solid year for the economy and markets. Employment continues to grow, both consumers and businesses remain confident, and markets have responded by moving up around the world, even hitting new highs here in the U.S. The fundamentals remain sound from both an economic and a market standpoint, and at this point, it seems likely the rest of the year will show continued growth and market appreciation.
There are risks, of course, but they are more political than economic. Even the real political risks, however, have not been as damaging as feared. Both the French and British elections, for example, failed to derail markets, and the political turbulence here in the U.S. has not prevented markets from reaching new highs. Strong economic fundamentals have allowed us to sail through the political storms, and this should continue to be the case.
The big picture, then, is one of continued improvement through the rest of 2017:
For the economy: Job and wage growth, along with high confidence levels and renewed business investment, continue to support the economy. A sharp decline in government spending, however, has turned into a headwind. We’re still growing, though, and that should continue through the rest of the rest of the year.
For interest rate and monetary policy: The Fed seems to be saying that the risks of not raising rates are greater than those of raising them. So, expect continued slow increases through year-end. Markets now largely expect continued policy tightening, so absent any surprises, the impact should be minimal, as it has been so far.
For the financial markets: Both revenue and earnings growth were greater than expected at the start of the year, a trend that should continue through 2017. Combined with high, though moderating, levels of consumer and business confidence, this trend should allow markets to rise even higher.
So, what kind of growth can we expect? I believe economic growth for 2017 will end up between 2.25 percent and 2.50 percent, somewhat below estimates at the start of the year, but still respectable. Constrained by this growth, inflation should remain near 2 percent. The Federal Reserve (Fed), encouraged by growth but limited by low inflation, will raise rates to 1.50–1.75 percent by year-end, which will drive the 10-year Treasury yield to around 3 percent. Finally, the S&P 500 will appreciate further, to 2,500.
None of this is guaranteed, of course. Things to watch at this point include the U.S. debt ceiling debate, the pending Italian election, and the situation with North Korea, among others. The biggest risk, at this point, appears to be the debt ceiling. This will require action by late summer, most likely. Should Democrats and Republicans be unable to agree, it could rattle financial markets, though the underlying strength of the economy is likely to limit the damage.
The biggest risk, given that strength, is that the expansion cycle has been much longer than usual, and the supporting trends are starting to decay. Still, based on history and current conditions, growth is likely to last through the end of the year.
While the risks are real, then, and growth will not last forever, the rest of 2017 looks likely to bring more of the same. More economic growth, slow but steady; more market appreciation, ditto; and more normalization across the board. After the turmoil in recent months and years, this is not a bad place to be.
Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. Emerging market investments involve higher risks than investments from developed countries and also involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation.
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