2016 Recap and a Look Ahead to 2017

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