From the Provident Investment Management newsletter
Support for earnings growth should come from a stable economy that is tilting toward more rapid growth. Consumer spending during the holiday season accelerated. The National Retail Federation reported year-over-year November and December holiday retail sales growth of 4% with a strong bump from online shopping of 12.6%. This growth rate excludes automobiles, gasoline stations and restaurants, but a separate report from the Census Bureau reported nice growth in December as well. Overall retail sales for December advanced 0.6% over the previous month and November’s gain was revised upward from 0.1% to 0.2%. Automotive sales had a large impact on December’s retail sales advance as the seasonal adjusted annual rate of new vehicle sales was 18.4 million units, contributing to a record-setting annual sales mark of 17.55 million units for all of 2016. When consumers feel confident in the future they buy long-lived assets like cars, so this is a good sign for 2017.
Further supporting 2017 is a stable, growing labor market. December saw employers add 156,000 jobs, which left the unemployment rate unchanged at 4.7%. October and November’s job gains were also revised upward a total of 19,000 jobs. While most economists consider unemployment below 5% as “full employment,” statistics looking deeper at the labor force, including a depressed labor force participation rate and those working part time jobs for economic reasons, suggest slack. Average hourly earnings growth year-over-year has ticked up to 2.9%, but this relatively low growth rate at this stage of the expansion implies the job market is in no way overheating.
Expansions usually don’t die due to old age but usually from economic shocks or policy mistakes. Both of these risks are present in 2017. Investors have responded to the positive pro-growth agenda of a unified Republican-led government by bidding up stock prices since the election. However, investors appear to be ignoring the anti-trade agenda of Donald Trump that could spark a trade war. About 30% of earnings from S&P 500 companies depend on international activity, so any shock from trade would surely disrupt growth. Further, the Federal Reserve has signaled that enough progress has been made in the labor market and inflation that it expects to raise interest rates during 2017. With GDP growth still averaging around 2%, the Fed could snuff out accelerating growth if it moves too far too fast.
For now, we remain optimistic that 2017 can see accelerating growth and continued advance of stock prices. However, with elevated stock prices it is more important than ever to select the right companies with management teams that can adjust to a changing economic landscape.