What do the major Wall Street players see coming down the pike in the New Year? Here are stock market outlooks for 2017 from seven strategists at some of the biggest investment firms, overseeing billions in client assets.
- Caution is Warranted
By John Velis
Bulls argue the election outcome has changed the game for the better. Deregulation, cutting taxes, and an infrastructure investment program all herald a pro-growth scenario. Forward-looking measures of economic growth are trending upward after a couple years of so-so readings.
Volatility is low. The rise in bond yields is positive, signaling the end of deflation and higher returns to capital. Cyclical and inflation-related equities — energy (XLE) and materials (XLB), industrials (XLI), financials(XLF) have rallied hard. Earnings expectations for these sectors are strengthening.
Yet caution is warranted because markets are betting big on the best possible developments in fundamentals. First, it’s unclear what form the new president’s policies will take and how much his policies will be accepted by Congress. Trump’s program is slim on details and potentially worrisome.
Furthermore, there is an argument that the long-run potential of the U.S. and other major economies is structurally and historically low, capping any upside to growth from policy. It’s not positive for risky assets to have an economy generating rising inflation while also being constrained by low to mediocre growth.
The Fed would face a difficult choice between keeping monetary policy loose to support demand and tightening to quell inflationary pressure; it may become the object of political pressure in either scenario. Reckoning with these risks will act as a break on any market upside.
Finally, beware of analogies between 1981 and 2017 when stocks took off under Ronald Reagan. Interest rates were historically high and set to fall for several decades. The opposite is true now. Stock market valuations were orders of magnitude cheaper than they are now, too.
John Velis is vice president of Global Macro Strategy for State Street Global Markets with $40 billion under management in Boston.
- The Stars Seem Aligned for a Positive 2017 for U.S. Stocks
By Andrew B. Wetzel, CFA
Investors believe that on balance, Donald Trump’s policies on tax and regulatory reform and infrastructure spending will lead to improved growth. This fits nicely with the trend in earnings and expectations for earnings growth in 2017. The seven quarters of year-over-year (Y-O-Y) declines in SP 500 (SPY) earnings, which were largely driven by the energy sector, bottomed out in Q2 2016 and Q3 2016 saw earnings per share (EPS) grow by 2.75%. The current consensus expectation is that EPS for the SP 500 will grow 12% in 2017.
Since the election, the market has quickly priced in the assumed winners and losers of the Trump era. Banks have rallied on higher interest rates and an expectation that the Dodd-Frank Wall Street Reform and Consumer Protection Act will be dismantled. Steel stocks (SLX) are up significantly on the idea that a Trump administration will limit cheap imports from China and South Korea. Engineering and construction stocks and associated construction equipment manufacturers have rallied on expectations that Trump will be able to push through a massive infrastructure package.
On the flipside, stable, high-yielding stocks in the consumer staples (XLP), REIT (VNQ) and utility (XLU) sectors have underperformed. Other recent assumed losers are technology (XLK), apparel manufacturers and other companies that manufacture products overseas, as fears of a heavy-handed approach to trade relations begin to creep into the market.
If growth picks up too quickly in 2017, the Fed will have to become more aggressive with the pace of interest rate hikes. Higher U.S. interest rates and continued low-interest rates in other developed countries will likely lead to a stronger U.S. dollar. U.S. dollar strength would pressure overseas profits and create a headwind for emerging market economies.
All of this could derail the earnings growth investors currently expect in 2017 and higher interest rates, all else equal, should pressure valuation multiples, potentially providing a double whammy for U.S. stock investors.
The one piece of advice that has worked in the past is to beware of chasing hot trends. These only last so long. The yield trade turned in 2016. The Trump trade will likely see a countertrend move at some point.
Andrew B. Wetzel, CFA, is a senior vice president and portfolio manager at F.L. Putnam Investment Management Company with $1.4 billion under management in Wellesley, Mass.
- The Only Certainty in 2017 is Uncertainty
By Michael Sonnenfeldt
The year will begin 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. But polling data suggests infrastructure spending to generate working class jobs is the single most important policy initiative expected by the electorate.
If taxes are reduced, and infrastructure spending is expanded, the deficit is almost surely going to rise, causing an increase in interest rates. Despite the opaqueness of the equity market unknowns, the fact of the matter is public equities have been falling out of favor with the high-net-worth for some time now, even as markets have risen to new highs since the election.
Our members’ investment holdings show that the aggregate allocation to public equities dropped by five percentage points this year, to 19% of total assets. This was before the post-election “bump.” This marks the lowest allocation our members have devoted to public equities since 2011.
The decline also pushes it from the second-most-favored asset class to third behind real estate (VNQ) and private equity. This is a notable shift downward, reflecting both a myriad of concerns about the public equity market and, not coincidentally, a surge in relative attraction to both real estate and private equity.
Following the trends of our members, large and mega-cap stocks are also losing favor. One year ago, TIGER 21 Members skewed towards preferring large-cap stocks. But this year only 39% of members mentioned large and mega caps as making up the majority of their portfolios. Mid-cap stocks now make up 17% of their equity allocations.
Perhaps the biggest lesson of 2016, one which certainly carries over into 2017, is that there is no safety in safety. The traditional assets investors sought refuge in for predictable cash flow, dividends or distributions have all been bid up to the point where their returns are no longer considered as attractive or safe.
Still the fact remains that in a low-interest rate environment if you are trying to stay “even” by sitting on the sidelines and not making any investments, you are probably going backward on an after-tax, inflation-adjusted basis.
Michael Sonnenfeldt is founder and chairman of TIGER 21 with $45 billion under management in New York City.
- Energy, Pharma, Defense and Materials Should Benefit From New Stimulus
By Humberto Garcia
As we approach 2017, we may be witnessing a generational shift of the pendulum away from globalization as nationalist fervor rolls across borders, and populist ideologues lead their political parties to power. This trend, experienced notably in the UK Brexit referendum and the U.S. presidential election, emerges from broader roots: World Trade Organization data show an increasing tendency and velocity toward trade restrictive measures worldwide.
In the U.S., the Keynesian embrace of fiscal stimulus as a solution to low growth could encounter headwinds as the two-toned flag of tax cuts and deregulation must withstand the countervailing forces of trade retaliation and a strong dollar, which may inhibit export growth.
Also, the pervasive short-term focus of boardrooms may lead companies to squander the corporate tax windfall on share buybacks and exuberantly-valued mergers and acquisitions. Peak market activity is already visible in deal multiples. And a cash infusion from the repatriation of capital could inflate valuations further. Tax policy should attempt to steer them toward business investment.