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2017 - What Does it Hold?

Posted by RAA on Jan 8, 2017 4:00:00 PM

market-updateAs we head into the new year, let’s briefly review 2016 and then discuss our outlook for 2017. When 2016 began, the S&P 500 stood at 2045 and as of November 4th it was at 2085, or essentially flat to modestly higher. This paralleled our 2016 outlook for a low return environment due to above average valuations.


After the elections, despite a high level of policy uncertainty, equity markets rallied. This post-election “feel-good” rally was due in large part to hopes that the new administration would reduce regulations, protect American workers, and institute a large fiscal stimulus program, all of which would be intended to stimulate growth.

The Investment Policy Committee (IPC) took the opportunity after the election to slightly increase portfolio risk relative to the market. However, as market sentiment about growth improved, so did the market’s expectations for inflation. Higher growth and inflation expectations caused bond yields to spike and as a result, the Barclays Aggregate Bond Index lost almost 3% during Q4. These bond market losses offset some of the equity gains in the balanced portfolios.

Currently, we think prices have gotten ahead of earnings and policy uncertainty remains high. And while this “feel-good” rally could last into early 2017, at some point, we expect a pullback in equity prices and bond yields.

Before we get to the stock market in 2017, let’s visit a subject that we have talked about a number of times in our newsletters: The Debt Supercycle. We feel that it ended for the consumer several years ago (but not for the government) and this has indirect consequences for corporate earnings and the stock market. We don’t believe the end of the Debt Supercycle means that lenders and borrowers (private sector, that is) have ended their love affair with debt, but we do feel that we can no longer assume that strong credit growth (low interest rates and monetary stimulus) will be a force boosting economic activity. In the Post-Debt Supercycle world, monetary policy (what the Fed does with interest rates) has lost its effectiveness at least in part because the velocity of money has slowed down.

Outlook for 2017

U.S. Stock Market:
As stated earlier, stock market valuations are currently not very appealing and there is possibly too much optimism about the outlook for earnings, and thus future returns. The outlook for earnings is the most critical issue when it comes to the long-term outlook for stocks, as earnings drive prices. Sometimes the price gets ahead of earnings (1997-2000) and sometimes it lags earnings (1980-1982 and late 2002-early 2003). Investors are excited about the prospect that U.S. earnings will benefit from both faster economic growth and a drop in corporate tax rates. However, earnings are not the only story.

One of the defining characteristics of the past several years has been the extraordinary performance of profit margins (how much of the “top line” drops to the “bottom line”). With nearly full employment, income for workers is starting to move higher, which is good for workers but not so good for profit margins. We currently think that analysts’ expectations for future earnings are too optimistic at this point in time. Poor valuations, over-optimism about earnings, and a reduced money multiplier, among other things, raise some concern for us about the long-term outlook for returns, but says little about the near-term outlook. The fact remains that conditions for an “overshoot” in the stock market could well persist into 2017 or longer.

U.S. Bond Market:
The late 2016 sell-off in bonds was dramatic, as prices dropped and yields rose from roughly 1.4% to over 2.5%. Though there may be some yield contraction in the near term in response to what may have been a “too far-too fast” price drop, we expect that in the longer term yield increases and price decreases will resume. This will likely mute bond investor returns for some time. While we are not expecting yields to start going back up immediately (this could be a long bottoming process), we do think that over the cyclical time frame, the direction for yields is up.

The result of the current bond market is that making money in bonds will be more challenging, but certainly not impossible. In conclusion, if the new administration is able to carry out most of their proposed policies, we could see economic growth pick up at a faster pace. For the last 8 years, GDP growth has been around 2% per year on average. While this level of growth is good compared to other developed countries, especially in Europe, there is a feeling that we can do better. Improved GDP will mean an even stronger economy, more jobs, potentially higher wages for the middle class, and ultimately a higher stock market, longer term.

Please contact us at (972) 684-5923 if you have any questions, or request a call with a Financial Consultant to discuss your unique situation.

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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by Retirement Advisors of America following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, Retirement Advisors of America accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds, and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Investment Updates