2017 Outlook
As another new year begins, we are happy to offer our outlooks for the markets and economy in 2017. What’s ahead for 2017? While uncertainty is high and optimism is cautious, here are some of our insights and expectations for the year ahead.
We Wish You a Happy & Healthy New Year!
John and Greg
US Stock Market:
After the worst start to a year ever, the US stock market staged a turn-around in 2016 with the Dow Jones Industrial Average making a late year ascent to nearly 20,000 lifted by a post-election rally. Looking ahead to 2017, the reminder that uncertainty is the only certainty in the stock market is especially clear. As the year begins with a new administration as well as the likelihood of the rise of interest rates, our nation’s fiscal policy, a key driver for the equity markets, has yet to be made known. While by definition future market direction is uncertain, perhaps it is the degree of current uncertainty that has Wall Street’s consensus 2017 S&P 500 forecast the lowest since going into 2005. That forecast is for just above a 5% gain for 2017. The S&P 500 has now been up on a total return basis for eight straight years. The all-time record for consecutive up years is nine (1991-1999).
As I noted in last year’s “2016 Outlook” earnings was one potential risk to the US stock market. This year, earnings may be the catalyst of a potential market upside surprise. It is expected that Donald Trump’s policies on tax and regulatory reform and infrastructure spending will lead to improved earnings growth. This fits nicely with the trend in earnings and expectations for earnings growth in 2017. The seven quarters of year-over-year declines in S&P 500 earnings, which were largely driven by the energy sector, bottomed out in the 2nd quarter of 2016 and Q3 2016 saw earnings per share grow by 2.75%. The current consensus expectation is that EPS for the S&P 500 will grow 12% in 2017. Throughout my years of analysis, company earnings stand out as the single most important determining factor to long-term stock price appreciation.
US Economy:
The U.S. economy has been expanding for seven years, more than doubling the average length of an expansion (38 months). Still, though, the economy is likely to deliver its 12th straight year of sub-3% Gross Domestic Product (GDP) growth in 2017, continuing the longest such stretch since World War II. GDP, the broadest indicator of the economy, measuring the value of final goods and services produced in the U.S., is likely to grow by just over 2% this year. Proposed tax cuts will have the quickest impact on the economy, but as demonstrated by the 2001 and 2003 Bush cuts, consumers tend to use the initial tax savings to pay down debts. Increased spending, which boosts GDP growth, tends to come later. Trump’s proposal for extra infrastructure spending probably won’t be approved by Congress until the 2018 fiscal year, which starts in October 2017. In the meantime, the rise in interest rates and the value of the dollar since the election will act as a drag on 2017 GDP growth. Similar to what I noted in my outlook for last year, the consumer will most contribute to the US economy in 2017. Strong consumer spending, driven by wage and employment gains, is likely to be the main pillar supporting the economy next year.
Interest Rates:
2017 begins like it did in 2016 relative to interest rates. After December’s rate hike, more interest rate increases are expected in 2017. There are key considerations that can influence interest rates in 2017 — an active Federal Reserve, a potentially bold President Trump, and a healthy (or alternately, stagnant) U.S. economy. Fed Chair Yellen said the Fed could raise rates three times in 2017. I am expecting two, anticipating that economic growth won’t be strong enough to warrant a faster rise in interest rates. It appears that 2017 will be the year the Fed gains more traction on its path to interest rate “normalization.”
Inflation:
While uncertainty surrounds President-elect Trump’s tax cut and infrastructure plans, they could further bolster the consensus economic forecast of rising inflation. The biggest boost to inflation is rising labor cost, which is expected to occur in 2017. A tightening labor market and increasing hourly earnings drive prices higher. Improving growth and the possibility of U.S. fiscal expansion is pointing toward more inflation. I see overall inflation to be 2.5% at the end of 2017, up from 2% at the close of 2016. Core inflation, which excludes food and energy, is expected to end 2017 at 2.3%, up just slightly from the 2.2% rate we expect for 2016. Other noteworthy inflation components beyond labor costs: Prices of groceries should fall a bit in 2017 due to greater competition in the grocery business. Dining out could rise as the cost of labor is a bigger expense than food for restaurants. Health care costs are expected to rise 4%-6% for employer plans and up to 9% for Obamacare plans. Prescription drug prices should ease slightly only because many price increases have already happened. Finally, a lack of homes for sale will put upward pressure on rents in many metro areas.
Global Markets:
The recent U.S. election and lingering effects of Brexit are creating global uncertainty heading into 2017. The global implications are trade protection, more restrictive immigration, fiscal stimulus and additional geopolitical risk. Future movements by central banks in developed markets are unclear, and emerging markets fundamentals are improving only in certain countries. Global monetary policy divergence remains an important theme in 2017, and I believe it will be magnified by a Trump presidency.
- Europe: Political risk is an issue for Europe with elections in Germany, the Netherlands, France and potentially Italy in 2017. Europe is also likely to see downside risk as the details of a negotiated UK exit from the EU start to take shape. A positive is Europe looks poised to benefit from stronger profits, the weaker euro, and a supportive European Central Bank policy. Consensus expectations for the euro-zone’s economic growth in 2017 is 1.4%
- Japan: Japan’s outlook depends on fiscal stimulus from Prime Minister Abe. This will push up inflation, lower real interest rates and put more downward pressure on the yen. The Bank of Japan has effectively promised to fully finance any further fiscal expansion. 2017 is the 5th year of “Abenomics,” the country’s economic revival program. Japan faces potential risks with a Trump presidency and in China’s growth forecast. Japanese stocks are more cyclical than most and tend to outperform when the global economy is improving. So, Japan should be a positive performing developed equity market in 2017.
- Emerging Markets: The leverage build-up across most emerging markets (EM) in recent years is still a concern, particularly in China, Russia, Brazil, Mexico and Turkey. The strong dollar and US Fed monetary policy are expected to remain sources of apprehension for EM investors. There are, though, a number of emerging economies benefiting from stronger exports, lower inflation and easier central bank policy settings. China’s leading indicators are starting to pick up for the first time in nearly four years. I think emerging markets need a Goldilocks scenario of robust global growth without an aggressive Fed or strong U.S. dollar to do well in 2017.
Post-Election Year: 2017’s post-election year has just better than a 50/50 chance of scoring a positive return for the S&P 500. The post-election year has been the weakest year in the presidential cycle in terms of the number of times the market has been up. According to FactSet Research, since 1933 the S&P 500 has been up 52.3% of post-election years. The average gain has been 5.6%.
Wishing you a great 2017!