"Ain't No Mountain High Enough"

"It is a cliché that financial markets advance by climbing a wall of worry. However, it doesn’t seem like a stretch to say that the stock market scaled a mountain of pessimism in 2016."

Who can forget the harrowing start to the year that saw markets plunge 13% in the first 20 days of January? China debt fears, global deflation, secular stagnation worries, the Brexit and the United States election surprises were the dominant headlines of 2016. Not surprisingly, given that long and gloomy list of variables, investor sentiment was morbid for much of 2016. In fact, according to the American Association of Individual Investors, the percentage of investors who said they were bullish about the stock market fell below 20% for four different weeks last year. To put this in context, since July 1987 there have only been 27 other sub-20% readings out of a total of 1,536 observations. Even in the depths of the 2008–2009 Great Recession there were only two such readings, and the low of 18.92%, on March 5, 2009, was registered a mere four days before the market bottomed.

While the overall environment was pessimistic in 2016, our analysis of the underlying economic fundamentals allowed us to remain positive. Paradoxically, while individual investors expressed bearishness toward stocks, they responded to consumer sentiment surveys by saying that they were increasingly feeling optimistic about their personal financial situation. Why? Because, as we have stated, they had spent years paying down debt and increasing savings. Importantly, we also correctly attributed many of the economic fears as short-term, negative side effects of a supply-driven oil price war. As the year progressed, economic growth strengthened as the oil shock subsided, lessening its effect on the manufacturing sector, while the increasingly confident consumer began opening up their pocketbooks. While many attribute the fourth-quarter U.S. equity market rally to the election, we would like to point out that there were other important factors behind the surge, such as the fact that recent global economic growth has surprised to the upside versus expectations at a level not seen since late 2013. Indeed, the Citigroup Major Economies Economic Surprise Index spent most of 2016 scaling the aforementioned mountain of pessimism. So it was improving economic data and a potential pro-business agenda from the U.S. President-elect Donald Trump that served as the backdrop for the market’s advance in the fourth quarter. Perhaps most importantly, as we opined, overly pessimistic investors were forced to rethink their skepticism and were the “buying fuel for the fire” that pushed U.S. stocks to record highs.

A Shifting Macro Backdrop

The marquee event of the fourth quarter, however, was the election. Without delving into the divisive world of politics, here is our nonpartisan economic takeaway: in the aftermath of the Great Recession, increased rules and regulatory laws were put in place to lower the risk of a future financial crisis. A focus on safety was a benefit that Americans wanted, and this search for safety occurred at the same time that America’s consumers, banks and government were practicing austerity and rebuilding their balance sheets.

Perhaps Americans are now perceiving and connecting (rightly or wrongly) the cost of these actions to slower growth, a toll they are no longer willing to bear. It now appears that there has been a pivot to a growth focus with fiscal spending as the new elixir. This may lead to a different set of future costs such as inflation, less safety and protectionism, to name a few. And this is not just a U.S. phenomenon – government spending, tax cuts, protectionism and nationalism are rising all over the globe (think Brexit).

The 2017 Economic Growth “Bean Counting Exercise”

We continue to believe that the underlying economic fundamentals point to ongoing, and likely rising, growth in both the U.S. and abroad in 2017. Thanks to the aforementioned balance sheet having been rebuilt, the U.S. consumer is now experiencing rising wages that are bolstering income and spending ability. U.S. banks, perhaps under a lighter regulatory touch, may be compelled to incrementally loosen their purse strings and lend more. And after years of contraction, U.S. fiscal spending looks set to be increased, which could mean a short-term boost for gross domestic product growth. As a sidebar, how many are aware that U.S. government investment recently drew down by the most since the 1950s?