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By Robert Johnson, CFA and Jeremy Glaser | 03-22-2017 01:00 PM

4 Factors Driving the Market

Morningstar's Bob Johnson sees these trends as being responsible for the shift in asset class performance so far this year.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We've seen a shift in asset class performance so far in 2017 from the end of 2016. I'm here with Bob Johnson, our director of economic analysis, to look at what he thinks of the four factors that are driving these shifts.

Bob, thanks for joining me.

Bob Johnson: It's great to be here today.

Glaser: So, the first factor you think is the change in relative growth rates between the U.S. and the rest of the world is driving some of the changes we're seeing in performance?

Johnson: Absolutely. I think that over the last three or four months we've seen the growth expectations for Europe, even Japan and emerging markets generally have been going up, maybe not a lot but a tenth or two. In the meantime, the outlook for the U.S. economic performance has gotten a little bit worse. I think people were thinking 2.25%, 2.5% growth for 2017. I think those numbers have come down to something that looks more like 2% or so. And certainly, the first quarter in the U.S. is going to be at a pretty dramatic risk, and we're going to be have one of our disastrous first quarters where we're going to have growth may be as low as 1% in the first quarter.

Glaser: So, that's leading to emerging markets and some other categories doing pretty well so far this year?

Johnson: Absolutely. Emerging markets have had a very good year because, you know what, emerging markets sell a lot to each other and as their economies all get a little bit better, that certainly helps and certainly, Europe is a key trading partner for emerging markets and Europe is even seeing the growth rates marked up a tenth or two. So, certainly, that's been good news for emerging markets.

Glaser: A lot of emerging markets have commodity exposure. You think that is the second factor here is that commodity prices, if not off to the races, at least look stable compared to where they were before?

Johnson: That's right. A lot of key economies in the emerging markets do depend on commodities which have done very, very well, maybe not so well the last month or so as oil has retreated just a bit. But in general, commodities have at least stabilized after kind of the disastrous situation over the last five years and that culminated in February of 2016. Certainly commodities have acted better and that's been better news for emerging markets in a general way, which are more dependent on commodities. Now, obviously, China and India are two countries that are less dependent on that obviously, but you've got Russia and Brazil, two other members of the BRICS that are very dependent on commodities and have been acting and doing better.

Glaser: The third factor is the stronger dollar, the continued strong dollar. How do you think that's impacting investment performance?

Johnson: Well, certainly, the strong dollar was something that's really happened last year and it's been happening over the last year, a year and a half. Now, so far in the beginning of 2017, the dollar hasn't been nearly as strong as people thought. People had suggested that the trading ratio between the euro and the dollar might drop to 1 to 1 and I can remember days when that was 1.4 to 1. So, clearly, some pretty negative expectations. Well, lo and behold, the euro actually stabilized in the first quarter, probably at least partially due to that better economic activity that I talked about. So, clearly, Europe has done just a little bit better here.

And also, what's happened now is the dollar gets a little weaker or at least stabilizes, that makes U.S. goods a little bit more competitive again or at least it doesn't worsen the situation. And certainly, that bodes well for the larger stocks that tend to sell more goods overseas and the smaller companies have done not so well in the first quarter as people are now saying, well, gee, maybe I want more exposure to exports and that faster growth we could see in emerging markets and that we could see in Europe even.

Glaser: The final factor is of course the Trump administration and potential policies that we could see change. How is expectations around what Trump's policies are going to look like shifted, say, since the inauguration?

Johnson: Yeah. I think there was almost an immediate and building momentum that a lot Trump policies, whether you view them as good or bad were likely to be implemented and implemented relatively quickly in 2017 and those centered on infrastructure spending and taxes. And so, as that process has slowed and there's a lot of give and take and there's going to be a lot of consensus-building, this has certainly taken longer than people thought. And so, those programs that were supposed to give us all tax cuts, more money to spend right away, more infrastructure building, which will require more commodities, well, now we've seen that market slow up a bit as kind of these policies get pushed out. They very well may be implemented. But what's happened is they have moved out here a little bit in terms of time and aren't going to benefit in the very, very short run here.

Glaser: So, you think that's also one of the factors but not the only factor that explains what's happening in the stock market?

Johnson: Absolutely. I mean, people want to say, oh, it's all the Trump trade and Trump-off type trade. But I think there's a lot more going on and a lot more nuanced to what's happening. I mean, certainly, in emerging markets we've had some attractive valuation. Emerging markets also have some more favorable demographics than here in the U.S. Those are all things that kind of got swept to the side in addition. Everybody has got trading partners outside of the U.S. and certainly, outside of the U.S. things seem to be getting better at a moment when U.S. economic activity seems to have stalled out a bit.

Glaser: Bob, thanks for the update today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.

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