The Presidential Inauguration is upon us, and the question remains of what will happen to our money, and our portfolios in 2017. Most banks put out an annual report about their 2017 Global and Domestic outlook for the year. Among the domestic reports, it seems the themes are more or less the same across the board. The majority of the published reports and analyst opinions consistently exclaim the following:
1. Inflation will rise in 2017 to about 2%.
2. Due to the fact that we will have higher inflation, it will allow the Fed to raise interest rates. Banks differ on how many rate hikes to expect and at what levels we can expect them to rise.
3. We can expect to see higher growth this year than we have in the past 8 years. We have been in the "snail economy" for quite some time, and may finally emerge from that. This growth can be tied to anticipated tax cuts and increases in infrastructure spending by the government (this is known as Fiscal Policy).
4. Equities are a better bet than bonds.
5. Nevertheless, Equities will be more polarizing than they have been in the past-- rather than all stocks winning or losing, performance this year will be based on which stocks and sectors are in a portfolio, rather than trends in the overall market. The sectors that different banks prefer are outlined below.
Below are summaries of the 2017 outlook of a number of major banks.
In Goldman Sachs' end of year report, 2017 US Equity Outlook: Democracy in America and the Triumph of Hope Over Fear, analysts believe that hope for lower taxes, reclaiming of foreign investment back to the US, and job growth will help fuel a modest surge in the S&P. They believe Q1 will see a 9% climb, to 2400.
The main recommendation Goldman makes during the "hope" phase is to buy cyclical stocks rather than defensives. Cyclical stocks are stocks that perform best when the economy is strong, but suffer when the economy is in a slump. For an example of a cyclical stock, you need to look no further than the automotive industry. More cars are sold when the economy is doing well, because consumers believe that their financial situation is strong, and that they have more money in their pocket. Defensives, however, are companies that have a lower correlation to the performance of the economy. Toilet paper, for example is a product that consumers will buy regardless of how much money they have made or saved, so a company that makes toilet paper would be considered more defensive than a company that only thrives during the good times.
Stocks that have high US sales exposure versus foreign sales exposure is another sector that Goldman recommends, as well as companies with high tax rates. This is because Trump has based his campaign on bringing companies with high exposure to foreign investment back to the US in order to bring more jobs back here. He has threatened to place a tariff on companies that have their operations and factories overseas. High tax rate companies will likely benefit in 2017 because Trump has based much of his economic policy on lowering corporate tax rates.
The details of Trump's corporate tax cuts are still undecided, but it is clear that companies that currently are in the highest tax brackets will see the most relief.
The report goes on to suggest fear will likely kick in in the second half of 2017, causing the S&P to pull back slightly, and end the year at 2300. It remains unclear what Trump's policies will be, and that uncertainty will be the catalyst for the pullback. We are anticipating corporate and personal tax cuts, but it is unclear when that will go into play, and by how much. There is more uncertainty than usual going into this year and expect no policy details will be available until March.
In terms of interest rates, the report anticipates 3 separate interest rates hikes in 2017. They believe company buybacks will rise by 30% as companies take back cash held overseas. Dividends will rise by 6% (4% is the current rate of growth on dividends). Growth should reach 2.2% in 2017. Since the election, we have seen heighted equity inflows ($36B), and bond outflows ($8B). As interest rates rise, bond holders may continue to sell as their values decrease.
Wells Fargo focuses their report, 2017 Annual Economic Outlook, Risk and Reward in An Aging Business Cycle, on what to expect from the business cycle. Interestingly enough, there is no life expectancy for the business cycle. They explain that "Business cycles do not die of old age but rather end due to unforecastable shocks". They believe the chance of a recession is very low. If we look at the recession probability model, it shows the probability of a recession at 7.56% in the next 12 months.
The report goes on to predict that inflation should reach 2%, and will allow the fed to continue to raise rates. The real question is if we are ready for rising inflation after a long deflationary cycle. The Presidential election brings a broader range of potential risks and rewards. The combination of potential tax cuts, reduced regulation and increased federal government spending for defense and infrastructure would keep employment and income growing quickly and efficiently, should they occur.
Confidence is at the highest level of the present cycle, as is consumer spending. This trajectory should continue as stronger job and income growth continue. In regards to housing, rising interest rates will lead to higher mortgage rates. Furthermore, rising home prices could make it even more difficult for homebuyers to obtain a home.
In BlackRock's 2017 report, Global Investment Outlook 2017, they highlight rising inflation as a key theme. Ultimately, they predict rising inflation will allow the Fed to increase interest rates back to normal rates. They believe fixed income has finally bottomed out, and as a result, Blackrock suggests stocks over bonds. As interest rates go up, the price of bonds goes down, causing the bond market to suffer.
Like its peers, BlackRock explains that the expected tax cuts and infrastructure spending could boost growth and inflation, creating another winning year for the US economy. We can expect to see a bigger dispersion between winning stocks and losing stocks. Blackrock has a preference towards dividend growers, financials, and health care stocks.
The report goes on to suggest the biggest risks in 2017 are the uncertainty and unknowns in regards to Trump's economic policy. It is still not clear what he will implement, how he will do it, and the timing of it all. They are hopeful that Trump's pledge to slash taxes and boost infrastructure spending will lead to growth, but that we don't know how much growth is expected, and what the potential side effects of these policies will be.
One topic that was unique to BlackRock's report was their input on diversification. They believe the old rules of diversification need to change. Traditional methods of diversification are different now. Stocks and bonds used to have opposite returns, but that is not the case anymore. We need to pick within each sector carefully.
In JP Morgan's Investment Outlook For 2017 report, they explain that Trump's policies could push forward the already existing trend of stronger US economic growth and inflation. This is a positive for stocks, but not for bonds. Nevertheless, there is still a need for diversification due to unknowns risks like global debt, and geopolitical threats.
The report goes on to suggest that interest rates should rise modestly in 2017, but not as quickly or aggressively as many of the other banks may predict. JP Morgan is the only firm that had anything good to say about bonds in the coming year. They believe bonds must be chosen carefully, focusing on credit or short duration bonds (low correlation to interest rate movement).
JP Morgan suggests that US equities should continue to perform well in the year ahead. Interest rates could polarize the US equities, with financials and technology winning, and defensives--such as utilities and REITS--losing.
They too are unsure of which policies Trump will implement, but it looks like they will go ahead with increasing defense spending and passing tax cuts, causing a pick-up in growth and in inflation. Next year may finally bring normalcy back into our economy; normal interest rates and normal inflation.
In the Morgan Stanley report, New Momentum for Aging US Business Cycle, they explain that the US economy looks ready for growth. 2016 had 1.6% growth; they believe 2017 will have 2% growth. They expect 2 more interest rate increases in 2017 bringing it to 2008 levels of 1.75%-2%.
As last year's decline in energy prices evaporate, energy sector investment is expected to rebound. This will help overall business investment go up from less than 1%, and closer to 2.8%. One area that creates some uncertainty is the strength of the US dollar; they expect it to appreciate further, making US goods more expensive for export. This adds a degree of uncertainty to the potential of growing US exports.
In terms of market recommendations, Morgan Stanley prefers small cap stocks over large cap stocks this year. Their report favors industrials over consumer discretionary, likely due to Trump's commitment to increase infrastructure spending. They also favor biotechnology to software, and utilities over consumer staples.
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