7 Economic and Market Themes for 2017

If you need a label for 2016, call it The Year of the Unexpected.

First, British voters shocked the world by voting to leave the European Union.  Then the Chicago Cubs stunned and delighted sports fans everywhere (expect Cleveland) by winning their first World Series in 108 years. And, in the year’s main event, Donald Trump was elected President of the United States, defying endless poll results and expert analysis that suggested such and outcome was somewhere between unlikely and impossible.

Not to be left out, the US stock market delivered its own unexpected outcome. After a 10% pull back in the very beginning of 2016, the worst ever start to a year, the market roared back to finish up more than 10%.

So, what will 2017 bring?  Every year the CIA investment committee attempts to identify the themes that will influence the economy and markets the coming year.  We do this by digesting a wide range of research reports and analysis from various sources and applying our collective years of accumulated experience and insight.  As 2016 reminded us, predicting the future is a dicey undertaking.  With that caveat, here are the trends we believe will shape 2017:

Trumponomics

Personal and income tax rates haven’t dropped significantly since early in the Reagan era when the top Federal income tax bracket fell from 70% to 28%. President-elect Trump is proposing a top bracket of 33%, down from today’s top rate of 39.6%.  He is also calling for a massive corporate tax rate reduction, from the current 35% rate down to 15%.

Trump’s appointment of business mogul and former corporate raider Carl Icahn as his special advisor on regulation suggests the President-elect is serious about slashing federal oversight of business.  Since 1976 the federal government has issued 180,000 new regulations, costing the economy an estimated 0.8% of GDP per year. When you do the math on 0.8% compounded over 40 years, it amounts to a massive multi-trillion-dollar drag on economic growth.

The prospect of lower taxes and less regulation should add significant lift to US economic growth, which has been stalled at under 2% for nearly a decade.

The downside of Trumponomics

If the economy begins to accelerate, interest rates would rise and the US dollar might continue to gain strength, pushing beyond its recent 14 year high. An extremely strong dollar has the potential to take a bite out of US corporate profits and could dampen US exports by making our aircraft, pharmaceutics, and automobile exports more expensive for other countries to consume.

Despite all of the potential Trump economic positives, many initiatives on the Trump agenda could lead to economic (or at least market) moderation later in 2017.   For example, Trump’s proposed trade tariffs could increase prices for many everyday consumer products items.  A 45% levy on Chinese goods could raise prices at Walmart a staggering 8%.

Stocks go from a “run” to a “jog”

The S&P 500 grew 8% in value during the last two months of 2016, which amounted to more than three-quarters of the entire year’s gain. This fevered pace will undoubtedly slow at some point in 2017.  Our data suggests that overall company earnings will climb nearly 10% in the new year.  But even if that happens, we look for market growth in the mid-to-high single digits in 2017.

The OPEC put

We expect oil prices to fluctuate in the $50-$65 range in 2017, largely due to ongoing talk of “supply reduction” coming from OPEC and other large oil exporting countries. We head into 2017 with a supply reduction deal on the table that is designed to put a floor under oil prices.  But US oil production continues to grow, and the Trump administration may revitalize some two dozen domestic oil infrastructure and pipeline projects.  These US energy developments would add to the world’s oil supply and thus serve to put a ceiling on oil prices.

Trump Sectors – Get “FIT” in the new year

From a sector perspective, look for Financials, Industrials, and Technology to do well as US GDP accelerates in 2017.

Financials should benefit from better net interest margins due to higher overall interest rates and the potential for less regulation.  Defense companies are also positioned to do well with Trump urging a 15%-plus increase in national defense spending.  Industrial companies should benefit from an increase in business spending on new infrastructure projects.  Technology firms should get a bump as companies increase IT spending in areas such as HR and employment services, as well as automation.  Lastly, higher average oil prices (compared to 2015 and 2016) should be a tailwind for energy company earnings.

Interest rates hit a ceiling

As the economy gains momentum in 2017 powered by the prospect of lower personal and corporate tax rates, we expect the Fed to raise interest rates at least twice this year.  That would come on top of a dramatic spike in rates during the last several months of 2016.  The 10-year Treasury went from 1.4% in the summer, to over 2.5% at year-end — an 80% increase.

Even if interest rates on the 10-year Treasury increases to 3%, which is the high-end of our expected range, that would amount to just a 20% rise in rates. That’s a far less dramatic increase than what markets already experienced in the latter half of 2016.

Bond investors get a raise

Bond investors have grown accustomed to interest rates steadily declining since Reagan came into office in 1980. The yield on the 10-year Treasury bond fell from 14% in 1980 to 1.4% this past summer.  This ongoing decline in rates has been a perennial tailwind for bond prices and investors, as bond prices move inversely with interest rates.  But the wind shifted in the back half of 2016 as rates began to rise.   On the upside, higher interest rates mean more income for investors moving forward.

As I said at the beginning, forecasting the future is tricky, but hopefully the above will help you as we enter 2017 with high hopes for a great year. As always, I’m here with my team at Capital Investment Advisors to answer your financial questions. We look forward to helping you make sense of these many happenings in the coming year.

Wishing you a prosperous New Year,

-Wes Moss, CFP® & The CIA Investment Committee

 




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