Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses the recent price and valuation increases in the equity market.
The risk‐on market environment triggered after the election remains firmly intact as 2016 comes to a close for equity investors. The traditional strong seasonal pattern is supportive through the end of the year and into the new year. But with prices and valuation elevated, the market is vulnerable should investor enthusiasm wane.
So far, the market has ignored the potential headwinds that may develop in terms of time and size regarding the expected fiscal changes. The Republican guard is going to be less than eager to increase government spending for infrastructure if it expands the deficit. Therefore, the final package could be much smaller or take longer to be agreed upon. Tax changes may not be as easy as expected as corporate lobbying efforts are pushing back on some of the current proposals being floated, such as the export/import tax adjustment. The premium valuation for equities does not adequately discount the risk of anti‐trade policies that could arise from the new administration. Any shift to a more cautious attitude toward the anticipated policies will likely result in market weakness. We think this will be an opportunity to accumulate equities, as the odds are high that market‐friendly policies will be passed and implemented.
Technical picture remains healthy. Broad‐based strength during the rally reflects a market with strong internals. Even the lagging transportation index reached a new high on December 7. Although the overall picture is positive, the magnitude of the recent price move leaves the market vulnerable to profit‐taking or at least a period of healthy consolidation. Any weakness, should it develop, is likely to be limited due to the aforementioned internal technical strength.
In sum, a positive seasonal period along with healthy technical trends are supportive of equity prices over the near term. But after the degree of the up‐move and with many unanswered questions regarding the political environment, stocks are likely to experience inevitable pullback periods. Absent a major deviation from the expected path of the new administration, we think weak periods should be used to accumulate equities.
Opinions expressed are those of the author and are subject to change. Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or any forecasts will occur. Investing involves risks including the possible loss of capital. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision.