fourth quarter 2016 market outlook - first midwest bancorp q4... · tend to be leading indicators...

Fourth Quarter 2016In this issue:• Economic Outlook — Kim Huebner, CFA• Stock Markets — Jason Bulinski, CFA• Interest Rates — Don Powell, CFAMarket Outlook

Year

GDP

Consumer Unemployment

Payroll Spending Additions

2016 Q3: 3.5% Q3: 3.0% December:

Dec: 156,000

Q2: 1.4% Q2: 4.3%

4.7%

YTD: 2.2 mil

Q1: 0.8% Q1: 1.6%

2015 2.6% 3.2% 5.0% 2,744,000

2014 2.4% 2.9% 5.6% 3,015,000

2013 1.7% 1.5% 6.7% 2,311,000

2012 2.2% 1.5% 7.9% 2,149,000

2011 1.6% 2.3% 8.5% 2,087,000

2010 2.5% 1.9% 9.3% 1,066,000Bureau of Economic

AnalysisBureau of Economic

AnalysisBureau of Labor

StatisticsBureau of Labor

Statistics

Growth: Business Spending Fuels Q3 Rebound

Real GDP increased at an annual rate of 3.5% in the third quarter of 2016, according to the “third estimate” released by the Bureau of Economic Analysis (BEA), up from 1.4% increase in real GDP in the 2nd quarter. This was due to increased spending.

Business spending (which represents 17% of economic spending) jumped 3.0% in the 3rd quarter, up from a decline of 7.9% in the 2nd quarter. Business spending rose across several categories…trade, inventories, and plant and equipment. The turnaround in trade contributed 0.85% to 3rd quarter growth (compared to a 0.18% contribution in the 2nd quarter), inventories contributed 0.49% (compared to a -1.16% contribution in the 2nd quarter), and investment in plant and equipment contributed 0.45% (compared to a -0.15% in the 2nd quarter).

Consumer spending (which represents 69% of economic spending) rose 3.0% in the 3rd quarter, down from an increase of 4.3% in the 2nd quarter. The bulk of consumer spending increases came from durable goods purchases (motor vehicles and parts). Consumers reduced or slowed spending on non-durable goods (clothing and footwear).

Government spending also increased in the 3rd quarter, up 0.8% (compared to -1.7% in the 2nd quarter), with the bulk of this increase coming from increases in national defense spending, likely a result of an escalation in the conflicts in Iraq and Syria.

Outlook: Economy Continues to Improve The US economy continues to improve due to business investment, consumer confidence, employment and real wages. As of January 3rd, the GDPNow model forecast for real GDP growth, 4th quarter 2016 GDP is expected to be 2.9 percent, up from 2.5 percent on December 22. This forecast is based on improvements in business inventory investment, as well as improved construction spending reported by the U.S. Census Bureau and the Manufacturing ISM Report from the Institute of Supply Management. For 2017, Bloomberg contributors expect real GDP to increase by 2.2% during the year. Contributors will adjust their estimates based on the current economic data as it becomes available.

The U.S. consumer is more confident. According to The Conference Board, “Consumer Confidence improved further (up 4.3 points) in December, due solely to increasing expectations relating to the post-election surge in optimism for the economy, jobs and income prospects, as well as for stock prices... Looking ahead to 2017, consumers’ continued optimism will depend on whether or not their expectations are realized.”

Economic Outlook

Market Outlook • Fourth Quarter 2016 1

Source:

Consumer Core

Producer Unit Year Price Index

PCE Price Index Productivity Labor

(CPI) (PPI) Costs

2016 November November November Q3 Q3 YOY: YOY: YOY: YOY - 0.0% YOY - 3.0% 1.7% 1.6% 1.3%

2015 0.7% 1.4% -1.1% 0.9% 2.0%

2014 0.8% 1.5% 0.9% 0.8% 2.0%

2013 1.5% 1.5% 1.2% 0.3% 0.9%

2012 1.7% 1.7% 1.9% 0.9% 1.7%

2011 3.0% 2.0% 3.3% 0.1% 2.1%

2010 1.5% 0.9% 2.8% 3.3% -1.3%

Bureau of Economic Analysis

Bureau of Labor Statistics



Federal Reserve Bank of St. Louis

Inflation: Within Fed Targets

Inflation, as measured by Core Personal Consumption Expenditures (Core PCE), the Federal Reserve’s preferred inflation gauge, rose 1.6% year-over-year in November. While Core PCE remains within the Fed’s acceptable range of 1% to 2%, the Federal Reserve continues to expect that the economy will experience higher inflation due to improvements in economic growth and employment gains. For this reason, on December 14th, the FOMC raised the Fed Funds rate target by 0.25% to between 0.50% and 0.75%. Other inflation indicators, such as the Producer Price Index (PPI) and the Goldman Sachs S&P Commodities Index, are rising. The PPI rose 1.3% year-over-year in November and the Goldman Sachs S&P Commodities Index, an overall view of commodities, rose 4.7% in December and is up 11.4% for the year. These two indicators tend to be leading indicators of future inflation.

Outlook: Inflation Contained But Rising The Fed expects that “as the transitory influences of earlier declines in energy prices and prices of imports continue to fade and as the job market strengthens further, inflation will raise to 2% over the next couple of years.” We are likely to continue to see inflationary pressures rise given:

• Year-over-year increases in import prices (which had been declining but are now rising)

• Unit labor costs (see chart)

• The employment cost index (total compensation increased 2.3% for the 12-month period ending in September 2016)

• Declines in productivity (see chart), and

• Rising commodities costs

Economic Outlook


Source:

Equity markets posted sharp gains in the 4th quarter. U.S. equity markets rallied on the belief that a new economic order will emerge under a Trump administration. The gains reflect investor expectations that lower taxes, less government regulation, and higher interest rates mean an acceleration of U.S. economic growth. Along with a reacceleration of economic growth comes a focus on corporate fundamentals as investors expect the decade long dominance of the central bank influence to take a back seat. The European Central Bank extended its bond purchase program but indicated the scope of the program would be reduced starting in April amid concerns that it may have run out of assets to buy.

China continued to show stable economic growth amid fears early in the year of a crash however the fears of a trade war with a new U.S. administration took its toll. The Federal Reserve moved to increase rates again with stronger indications of a tighter policy in the future.

According to FactSet, 4th quarter S&P 500 operating earnings are expected to advance 3.2%. It will mark the first time the index has seen year-over-year growth in earnings for two consecutive quarters. Nine of eleven sectors are reporting positive earnings growth led by the materials, financials, and utilities sectors. The industrials and telecom sectors are reporting year-over-year earnings declines.

S&P Russell Returns DJIA S&P 500 2000 NASDAQ Internat'l Emerging 500 (Mid) (Small) Developed Markets

4th QTR 8.66% 3.82% 7.42% 8.83% 1.34% -0.72% -4.16%

2016 16.49% 11.96% 20.74% 21.31% 7.50% 1.01% 11.20%

2015 0.2% 1.4% -2.2% -4.4% 7.1% -0.8% -14.9%

2014 10.1% 13.7% 12.3% 4.9% 13.4% -4.9% -2.2%

2013 29.7% 32.4% 33.5% 38.8% 38.3% 22.8% -2.6%

2012 10.2% 16.0% 17.9% 16.3% 15.9% 17.3% 18.2%

2011 8.4% 2.1% -1.7% -4.2% -1.8% -12.1% -18.4%

2010 14.1% 15.1% 26.6% 26.9% 18.2% 7.8% 18.9%

Quarter: Bulls Are Energized!

Stock Markets


Shown below are earnings growth estimates for the S&P 500.

S&P 500 Operating Earnings Growth Fact Set 2017 2016 2015

Year 11.5%E 0.2%E -1.7%

Q4 - 3.2% -5.5%

Q3 - 1.6% -1.5%

Q2 - -3.2% -0.7%

Q1 - -6.6% 0.8%

Near-term, higher volatility could come from the market’s post-election rally as investors’ expectations are high with regards to the Trump administration’s agenda. Whether or not the markets borrowed gains from 2017, Barron’s top strategist December survey has the S&P 500 up 5% on average with 100% consensus the markets will have positive returns for 2017.

There are several factors that can push US equity markets higher. The equity market continues to benefit from improved earnings growth but has not had the help of global economic growth yet in this recovery. Early signs of improving global economic growth include coordinated monetary stimulus and cheaper currencies in Europe and Japan. However, protectionist trade policies and renewed risk of the Eurozone’s breakup may add to volatility.

As for equity valuations, many stocks are expensive in comparison to their 5-year, 10-year, and 15-year P/E averages. According to FactSet, the 12-month forward P/E ratio of 16.9 is above the 5-year average of 15, 10-year average of 14.4, and 15-year average of 15.3. Analysts are projecting record level EPS for 3 of next 4 quarters. If growth comes slower than expected, the markets only look more expensive. On the other hand, a pro-business multiplier effect from tax cuts, higher government spending, and less regulation could provide the up side we haven’t seen in this economic recovery. The economy has yet to sustain a real growth rate above 3% as we enter the 9th year and third longest recovery according to Ned Davis Research.

Outlook: Higher Volatility But Higher By Year End


Stock Markets

3 Mos 6 Mos 2 Year 5 Year 10 Year 30 Year 2-10 Year T-Bill T-Bill Treasury Treasury Treasury Treasury Spread

12/31/16 0.51% 0.62% 1.20% 1.93% 2.45% 3.06% +125 Yields

9/30/16 0.27% 0.43% 0.76% 1.15% 1.59% 2.32% +83 Yields

QTR 0.1% 0.1% -0.5% -3.3% -6.8% -13.7% — Returns

YTD 0.3% 0.7% 0.7% 0.5% -0.2% 0.9% — Returns

12/31/15 0.17% 0.48% 1.05% 1.76% 2.27% 3.02% +122 Returns

12/31/14 0.04% 0.12% 0.67% 1.68% 2.17% 2.75% +150 Returns

12/31/13 0.07% 0.09% 0.38% 1.74% 3.03% 3.97% +265 Returns

12/31/12 0.04% 0.11% 0.25% 0.72% 1.76% 2.95% +151 Returns

12/31/11 0.01% 0.06% 0.24% 0.83% 1.88% 2.89% +164 Returns

12/31/10 0.12% 0.18% 0.59% 2.01% 3.29% 4.33% +270 Returns

Mortgages High Returns Treasuries Agencies (Agency) Corporates Municipals Yield

QTR -3.9% -2.1% -2.0% -2.9% -3.5% 1.9%

YTD 1.1% 1.5% 1.7% 6.0% 0.4% 17.5%

2015 0.8% 1.0% 1.5% -0.6% 3.3% -4.6%

2014 6.0% 3.4% 6.1% 7.5% 9.1% 2.5%

2013 -3.4% -1.8% -1.4% -1.5% -2.6% 7.4%

2012 2.2% 2.4% 2.6% 10.4% 6.8% 15.6%

2011 9.8% 5.3% 6.1% 7.5% 10.7% 4.4%

2010 5.9% 4.6% 5.7% 9.5% 2.3% 15.2%

Quarter: Higher


went from 83 basis points on September 30th to 117 basis points on November 9th (the day after the election). By December 31st, the spread had widened further to 125 basis points. The yield curve steepened as the 10 year treasury yield rose faster than the yield on the 2-year treasury.

Corporate and High Yield bond spreads also narrowed during the quarter as confidence increased that the US was not entering into recession territory. Investment grade spreads narrowed by 13 basis points from 142 basis points on September 30th to 129 basis points on December 31st. Junk spreads narrowed by 81 basis points from 502 basis points on September 30th to 421 basis points on December 31st. As recession fears faded, junk posted the best return for the month and year. Shown below are various fixed-income returns.

Interest Rates

US interest rates rose during the quarter and accelerated following the election on November 8th. The market was anticipating an interest rate hike in December and started to price in “pro-growth” policies from the new President-Elect Trump. The yield curve moved higher and steepened. The spread between the 10-year Treasury and the 2-year Treasury

The market has priced in a lot of “hope” that President-Elect Trump will deliver on his promises of 1) tax reform (both personal and corporate), 2) Infrastructure spending (from repatriation holiday), 3) Repealing the Affordable Care Act (Obamacare), 4) Increased Defense spending, and 5) Immigration reform. Market consensus is that these “pro-growth” policies will be implemented relatively quickly following inauguration. In reality, it may be longer given the fact that it took President Obama nearly 6 months to implement some of his plans and he had a super-majority in congress to support him. President-Elect Trump doesn’t have as strong a majority as President Obama had and doesn’t have full support of his party as well.

The Federal Reserve indicated 3 rate hikes in 2017. The economy has shown signs of improvement. 3rd quarter GDP growth was revised up to its fastest pace in two years (3.5% from 3.2%), led by stronger Capital Expenditures (capex). Improving momentum in capex goods orders bodes well for future factory activity. The ISM Manufacturing Index ended the year on a high note finishing at 54.7, its highest level in two years. Consumer confidence is at its highest level since 2001. However, personal income and spending data show economic growth has softened in Q4. The Leading Economic Indicators suggests moderate growth in the 1st half of 2017. According to a Bloomberg survey of 49 economists, there will be a 25 basis point increase in July and another 25 basis point rate hike in December. This would bring the fed funds rate to 125 basis points by the end of 2017. Expect the 10-year treasury could yield 2.77% by year end.


Outlook: 2017

Past performance is no guarantee of future results. This commentary has been prepared for informational purposes. Information and opinions expressed herein reflect our judgment and are subject to change.Wealth Management services are offered through First Midwest Bank. Most wealth management products are not FDIC insured.

fourth quarter 2016 market outlook - first midwest bancorp q4... · tend to be leading indicators...

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