Now we know. What was a mystery coming into the fourth quarter is now history. When uncertainty is eliminated the market breathes a little sigh of relief. Equity markets advanced to new highs in the fourth quarter amid political news that drove a variety of strong emotions across the U.S. and the world. Three major events occurred in the fourth quarter.
- Central Bank Action/Inaction
- Third quarter earnings/GDP
- S. Presidential Election
The November U.S. Federal Open Market Committee (FOMC) meeting came and went with little volatility as the committee took no action amidst the U.S. presidential election. As projected, the FOMC cited moderate growth and low inflation as an opportunity to raise interest rates for the first time in a year. The federal funds rate target range rose from ½ to ¾ percent. Widely anticipated, bond traders drove 10-year interest rates up sharply throughout November and December to a peak over 2.5% on December 16th for the first time since 2014 – 2.5% is a sharp increase from the 2016 low of less than 1.4% in July.
Third quarter GDP growth was 3.1%, the fastest growth rate since third quarter 2014. Inventory investment and stronger business investment in software and research and development helped drive growth. Revenue growth was also solid, up 2.7% for the quarter. Real estate companies continue to experience strong recovery in earnings, while consumer discretionary reported the strongest year-over-year rise in revenue. Positive earnings growth is expected for the fourth quarter, which would mark the first consecutive two quarters of growth since 2014.
Finally, the U.S. election came to a close with Republican Donald Trump claiming victory. Republicans made a strong statement by also retaining control of the House and Senate, thus giving Republicans two years of “unified” government. After a sharp decline in overnight markets due to the unexpected victory, equity markets increased on optimism that Trump and Republicans will move forward with a pro-growth, pro-business agenda.
2017 is sure to contain its own share of surprises, as the new U.S. leadership takes control and hits the reset button. It remains to be seen what action takes hold first and at what pace change occurs. Coming into 2017, equity markets remain strong due to positive economic and earnings growth. Some caution is warranted as we look at equity valuations that are the highest they have been since 2009. A return toward past earnings for energy stocks will be watched closely to help justify current price levels.