Key Points
▪ The dramatic shift in financial markets after the election shifted the scoring of our predictions — mostly for the better.
▪ Faster economic growth, higher inflation and improving corporate earnings may cause government bonds to struggle, while creating tailwinds for equities in 2017.
When we made our predictions in January, a key theme was that 2016 would be a year that would frustrate both the bulls and the bears. That was the case for most of this year before the post-election rally and second-half improvement in economic and earnings results. In fact, markets changed so dramatically that several of our predictions moved from “incorrect” to “correct” (and one might wind up moving the other way). In any case, as we look back on 2016, most trends happened broadly the way we had forecasted:
1. U.S. real GDP remains below 3% and nominal GDP below 5% for an unprecedented tenth year in a row.
Although economic growth and inflation both picked up as the year drew to a close, first half of 2016 saw enough economic weakness that this prediction was never really in doubt.
2. U.S. Treasury rates rise for a second year, but high yield spreads fall.
High yield spreads moved unevenly, but have fallen from 660 basis points to 405 basis points.1 A few months ago, we didn’t expect to get the first half of this one correct, but the 10-year Treasury yield rose from 2.27% to 2.59% so far this year.
3. S&P 500 earnings make limited headway as consumer spending advances are partially offset by oil, the dollar and wage rates. Corporate earnings were negative for the first half of 2016 before beginning a recovery in the third quarter.
4. For the first time in almost 40 years, U.S. equities experience a single-digit percentage change for the second year in a row.
The recent upside breakout in stock prices puts this one in jeopardy. The S&P 500 Index closed last year at 2,044, so the magic number for a 10% move is 2,248.2 If the index closes at this level or below on December 30, we’ll get this one right. At Friday’s close, it stood at 2,258.2
5. Stocks outperform bonds for the fifth consecutive year.
Thanks to the post-election rally in equities and spike in bond yields, this one was easily correct.
6. Non-U.S. equities outperform domestic equities, while non-U.S. fixed income outperforms domestic fixed income.
U.S. stocks have outperformed most other markets. In contrast, non-U.S. fixed income has outperformed U.S. fixed income. (The Bloomberg Barclays Global Aggregate Bond ex U.S. Index is up 1.7%, compared to 1.5% for the Bloomberg Barclays U.S. Aggregate Bond Index).2
7. Information technology, financials and telecommunication services outperform energy, materials and utilities.
This is the other prediction that remains too close to call as markets have been shifting dramatically in recent weeks. A basket of our favored sectors is up 19.4% for the year while our least-favored are up 21.0%.2
8. Geopolitics, terrorism and cyberattacks continue to haunt investors but have little market impact.
Geopolitics grew more complex while terrorism and cyberattacks became increasingly common. Overall markets effects, however, have been limited.
9. The federal budget deficit rises in dollars and as a percentage of GDP for the first time in seven years.
Following three years of declines, the deficit rose by $150 billion this fiscal year to nearly $600 billion.3
10. Republicans retain the House and the Senate and capture the White House.
The only thing more surprising than Donald Trump’s victory was how brief the market sell-off was. Trump’s victory likely means we’ll see more progrowth policies, but also presents uncertainties and political risks.
Looking Ahead
Our 2017 predictions will be available in early January, but in advance of that, we can offer broad themes for the coming year. We expect economic growth will accelerate modestly in the U.S., partially due to a range of pro-growth initiatives from the Trump Administration. We think some of these same factors will likely put upward pressure on inflation, and expect corporate earnings to continue to recover. Should events come to pass in this manner, it would probably mean an environment in which government bonds struggle and equity prices rise unevenly. More importantly, we expect 2017 to be a year in which selectivity grows in importance as markets become more dynamic and divergent.
1 Source: Bloomberg. Spreads reflect the option-adjusted spread of the Bloomberg Barclays High Yield 2% Issuer Capped Index relative to Treasuries
2 Source: Morningstar Direct, Bloomberg and FactSet as of 12/16/16
3 Source: Congressional Budget Office
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a priceweighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000 Index measures the performance approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone.FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income. Bloomberg Barclays Global Aggregate Bond ex. U.S. Index provides a broad-based measure of the global investment-grade fixed income market outside of the United States.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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