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Market rally enters “Show Me” phase

January 16, 2017

ralph-coleby Ralph Cole, CFA
Executive Vice President of Research
Ferguson Wellman,
A leading Oregon financial firm
January 13th — After rallying into the end of 2016, both interest rates and the stock market took a little breather this week. The S&P 500 finished the week basically flat, while the yield on the U.S. 10-year Treasury finished at a 2.40 percent. A quiet week as we head into earnings season.

Getting Ahead of Ourselves

Part of our theme for 2017 is that the market rallied a great deal at the end of last year in anticipation of economic growth that would occur in the near future. As such, we have pulled forward returns before we’ve seen actual improvement in earnings and growth. There was no place where this was more apparent than the financial sector the S&P bank index was up 23 percent between November 8 and year end. Today, several of the biggest banks announced fourth quarter earnings, and despite relatively upbeat reports, the stocks didn’t move much.

Specifically, Bank of America, PNC Financial Services, JPMorgan Chase and Wells Fargo all reported earnings this morning. It appears that the benefits from higher interest rates are starting to show up in bank earnings as banks have been able to raise what they charge on loans faster than they have raised what they are paying depositors. Also, continued strength in the economy is allowing for additional reserve releases (credit quality remains very strong). One area of weakness with the recent rise in interest rates has been the mortgage business, with refinancing activity dropping dramatically.

We think we are moving into the “show me” phase of the recent market rally. By that, we mean that companies will need to justify the recent moves in their stock prices. Not necessarily with strong fourth quarter earnings, but with an improved outlook for 2017 sales and earnings.

A Bi-Partisan Issue

Many expected that Hillary Clinton would be critical of the drug industry, but it now appears that both presidential candidates believe that drug prices are too high. Donald Trump held a press conference this week to highlight some of the priorities for his administration and he put the pharmaceutical industry on watch with his line, “drug companies are getting away with murder.” It remains to be seen what affect the Trump administration’s health plan will have on drug prices over the long-term, but we know that at present there is substantial “headline risk” associated with the sector. We continue to see value in healthcare stocks, but it may take time to realize that value.

Takeaways for the Week

· Lots of good news is already imbedded in current stock prices

· The new administration intends to make good on some of their populist rhetoric

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