The Economy and Markets Mid-Year 2017

It’s hard to believe tomorrow is July 1—the halfway point of 2017. The first half of the year, eventful as it was, has simply blown by. And now that we are moving into the second half, it’s time to take a look at the stories that are likely to play out in the economy and markets over the next six months.

Politics and the economy: A stable picture

Overall, political and economic improvements have largely stopped. That’s not to say that things will start to decline this year, but I think stability is likely to be the best we get.

The stabilization is most apparent politically. Expectations for economically positive policy changes were high after the election and in the early part of the year, but the recent back and forth over the health care bill, in particular, has put the country on notice that any further policy changes are likely to be less comprehensive than had been hoped. In fact, the gridlock we see in DC has a distinct resemblance to what occurred under the past administration. At best, progress will be slow, and consumers and investors have been adopting more of a “show me” attitude as a result.

Economically, although consumer and business confidence remain strong, they still haven’t translated into any meaningful spending growth. Consumer spending and business investment did improve through the first half of the year, but they have stabilized and even pulled back recently. With politics no longer promising to make things better—and quite possibly setting up to make things worse—consumers and businesses continue to defer spending decisions even as their earnings and balance sheets improve. As caution has replaced optimism, many of the current data has gotten weaker, a trend that could well continue.

None of this is to say things are bad. In fact, growth continues and is likely to keep going at the current pace of around 2 percent for the rest of the year. Here again, though, significant improvement has become much less likely.

Financial markets: A modest outlook

What’s happening politically and economically is translating to the financial markets as well. After a very strong first half, the second half is looking much less exciting, at least on the upside. Corporate earnings are likely to keep improving, but expectations are already high—and will be difficult to meet. Hope of policy changes drove markets in the first half, and that tailwind will be missing in the second. The pullback we have seen in June may be a signpost of how the rest of the year shakes out, with overvalued stocks and sectors reverting to reality. I think we will see more gains but at a much more modest level going forward.

Risks are also rising, as consumers and investors grapple with the current good conditions versus a more uncertain future. At some point, it is likely they will get scared, and the current calm will vanish.

Negotiating the transition

Transitions are always the trickiest part of a cycle to negotiate. While the recovery continues, the best part of it is likely over, and we are moving into the later part of the cycle. We have had a great first half, and investors are very complacent, but that is not a sign of calm going forward.

Indeed, while the second half should be positive, now is the time to think about what happens as the economic cycle really turns and worry reasserts itself in the form of market volatility. Even if it doesn’t happen this year—and it might not—we’re still likely to get closer to that point in the second half of the year.