2017 US Equity Market Outlook

January 3, 2017 11:28 am

Betsey A. Purinton, CFP®

Managing Partner & Co-CIO

Investors are forever hopeful (why else would we invest?). And the start of a new year often brings outsized optimism.  2017 feels particularly bullish for the equity markets, however, with both investors and businesses cheering. I feel the same hopefulness, but I am reminded that 2016 was humbling in many ways.

2016 did not go according to plan. Consensus opined that the year wouldn’t start with a very serious correction. Nor was there supposed to be a significant rally at the end of the year (not to mention Brexit or Trump’s election, etc. in between).  But markets have a way of shaming hubris and rewarding contrarians. They keep all of us money managers on our toes.  So with this in mind, we offer our 2017 Equity Market Outlook and a reminder that it represents only how we feel on Day 1 of the New Year.

Economic Outlook
Our top down economic overview is positive. We begin with Trumponomics – Trump’s policy reforms – which have received a lot of press in the last six weeks and are currently factored into equity prices. However, if enacted as intended, Trumponomics is still likely to bring more positive returns to the markets.

The primary beneficiaries of Trump’s policy reforms are businesses. (And since equities are shares of businesses, our focus is on how companies will fare under the new administration). From 2009 to the present, business investment and spending has been underwhelming. Consumers, on the other hand, have done their job reigning in debt and dipping into their pocketbooks. Because consumers represent 70% of economic growth, they have been the most responsible in keeping the US out of a recession these past eight years. Businesses, on the other hand, have been much more cautious: maintaining cash on hand or parked overseas, hiring relatively sparingly, and hesitating on investment in equipment/technology in order to increase productivity and efficiency. Businesses as a whole have tended to slash costs to preserve profits and huddle on the sidelines, waiting out the uncertainty.

President Elect Trump, along with a Republican House and Senate, represent a pro-business, pro-growth platform, with proposals to decrease business taxes, repatriate dollars from overseas, reduce regulation, and increase fiscal spending. If the 30% of gross domestic product (growth) represented by businesses improves, the hope is that the US economy could reach “escape velocity” or the speed at which our long-suffering recovery could develop enough oomph to take us beyond our malaise.

From our perspective, the most important aspect of the Trump/Republican plan is the degree to which it inspires business confidence. For years corporations have taken earnings and applied them most frequently to stock buybacks or dividend payments for the shareholders, a less productive (but much less risky) use of money than investing in plant, equipment and people. Now the challenge is getting businesses to buy into the Trump vision that America can be great for them not just for voters. The good news is that since the election, purchasing managers at corporations are reporting more activity while small business sentiment has shot up, signaling that sidelined money and profits might soon be reinvested in company growth.

But, as always, there are caveats. Will government initiatives take too long? Will they be watered down? Will debt hawks waylay plans? Will protectionism and trade policy offset the growth initiatives?  It is too soon to tell, but one thing is certain: US businesses may have a better shot at improving the economy and their earnings than they have had in a long time.

Equity Market Outlook
What, specifically does all this mean for the US equity markets and your investments? From what we know at this point, here is what we are seeing:

2017 may be another positive year.  Although markets have already rallied, there may still be room for equity prices to increase. Many analysts and strategists are pegging average equity total returns over the next 5-10 years at around 5-8%. These are lower than in the past due to headwinds from: higher interest rates, increasing wage costs, modest overvaluation, and slow global economic growth. But these same strategists are also conceding that some sectors and or stocks could do far better than others.

Since 2008, for the most part, the broad indexes have outperformed concentrated positions, as sectors rapidly rotated in and out of favor and positons became highly correlated – pricing in tandem with each other. As we move into a more traditional late business cycle period, certain sectors, in particular the value sectors, such as financials and energy, could do better than defensive or interest rate sensitive sectors, such as utilities and consumer staples. In addition, valuation does matter and those sectors that have underperformed over the last few years, we believe, could be better positioned to make larger gains. There are also bets that can be placed based on increased capital expenditures (technology and industrials). With such low anticipated overall returns investors may wish to add targeted positions beyond broad indices.

Two more caveats:

  1. Equity markets tend to look like sharks teeth – jagged peaks and valleys – rallies and pullbacks. January or February could deliver a mild retreat in prices as investors, who waited to take profits until the new tax year, sell and reposition their portfolios. Or markets could become disillusioned with the progress of Trumponomics later in the year and give back some of their gains. Or simply, the unexpected happens. Bull markets are meant to be interrupted. If the overall market outlook remains positive, we could see a year of investors buying on the dips, rather than panicking during retreats.
  2. Diversification is your long term friend, but not always your short term best pal. Q4 2016 saw the S&P rise 3.25% (the S&P fell modestly October – November 8th, then bounced back during the post-election rally). But bond funds fell 3.12% (iShares Core US Aggregate Bond Index); Emerging Markets dropped 4.6% (MSCI Emerging Markets Index); and Developed Markets dipped 1% (MSCI EAFE Index). If you were invested in a balanced portfolio that included bonds and international holdings as well as the S&P 500, you could have been disappointed by your last quarter’s returns. But come the next bear market, you could be very happy that you stayed diversified.

We wish everyone a profitable start to the New Year. In the coming weeks we will also review the fixed income markets and the overseas markets.

Betsey A. Purinton, CFP® is Managing Partner and Chief Investment Officer at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at bpurinton@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.