Wednesday, December 21, 2016

2017 Stock and Bond Market Predictions

Regrets for taking so long between posts. I plan to be better about posting next year...get more exercise...and more sleep.

Before moving on to the 2017 forecast, let's take a look at what took place in various segments of the markets in 2016, including the impact of major political developments on those markets. The S&P currently stands at 2265, up 10.8% year to date. Fully 8.7% of these gains, however, occurred in the last five weeks following the US Presidential election. 

Equity markets fell sharply early in 2016, largely on China worries, falling commodity prices, a collapse in oil prices and record low bond yields. By mid-February, the S&P 500 would fall by nearly 10%, before snapping back to rally to new highs in mid-April. But by July the market was up just 5% on the year, and with some volatility, stayed in this range pretty much up until the November election. 

Major political events, unexpected and shocking to many like Brexit, the Trump victory and the Italian referendum would disrupt markets, but with ever shorter periods of recovery, before pushing to new highs. It's been said that the stock market took three days to recover from Brexit, three hours to recover from the Trump victory and three minutes following the Italian referendum. Amidst these recent, post-election gains, however, and with new infrastructure spending still years away (if at all) the rise in stock prices has been entirely attributable to price/earnings multiple expansion. The S&P 500 now stands at 26x 12-month trailing earnings, second only to historic peaks in 2000 and 2008.

Oil played a major role in markets in 2016, with WTI falling below $27 per barrel in January. Soon thereafter rumors of planned price collusion of OPEC began to swirl, first at Doha, then Algiers and finally Vienna. By the time a deal had been struck, it was early December, with oil prices artfully manipulated for the entire year. Despite the recovery in prices and the alleged OPEC deal, however, oil remains vastly oversupplied.  US EIA data indicates that average daily global oil storage builds in 2016 are expected to average 700 million barrels, dropping to 400 million barrels per day in 2017 (presumably on the OPEC cuts). Oil in storage in the US is just below 500 million barrels (and well above five-year historical averages for this time of year) while oil stored at Cushing, Oklahoma is rapidly nearing capacity.

The UST 10-year bond yield would begin the year at 2.27%, approximately 26 basis below its current level. For all the drama about soaring bond yields, the 10-year is at levels of June 2015 and 50 basis points below its levels of January 2014. That being said, the sell-off in bonds in the latter part of this year, was swift and severe. The 10-year hit a low of 1.46% in July 2016. While yields crept higher thereafter, the 10-year would still be trading at just 1.56% at the end of September. 

What followed for bonds was increasing concern about the Fed, on hold for the entirety of 2016, but widely expected to hike the fed funds rate this past fall. After numerous false starts in June, July, August and September, the Fed would finally hike, but not until mid-December (and then, by just 0.25%). In it's forecast for 2017, the Fed indicated that it would likely hike rates another three times, which spooked a market that had been predicting two hikes for 2017. Turns out, the Fed actually dialed back its hawkishness from the four rate hikes it predicted for 2016 (again, only to raise just once).

But it was the Trump victory in November that greatly accelerated the sell-off in bonds, and with it, interest rate sensitive stocks like utilities, REITs, Telcos and other dividend plays. In moments following the election, investors became rapidly convinced that a Trump Administration, supported by a Republican House and Senate would move swiftly to implement tax cuts, infrastructure spending and financial deregulation. Markets quickly concluded that lowered tax revenue, coupled with greater fiscal spending could only mean greater deficits and, with them, a rapid acceleration of inflation. Long-term interest rates promptly reacted. Yields on the UST 10-year would jump by 70 basis points in just five weeks. But what does all this imply for 2017? Perhaps not what many are thinking.

Part 2, a forecast for 2017 will follow in the next few days...I promise.