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.

Bank Earnings Blowout (Reprise)

JP Morgan, Citi and the tarnished Wells Fargo all reported third quarter earnings this morning. The press was ecstatic. CNBC's original headline "J P Morgan Crushes Expectations", was quickly revised to read "JP Morgan Profit and Revenue Easily Tops Forecasts". At Business Insider, the headline was even more bold: "JP Morgan Smashed it out of the Park". The headline for Citigroup's release at CNBC was "Citigroup Tops Wall Street Expectations for Earnings and Revenue".  

But none of these titles accurately captures what is going on with bank top line revenue or profits. Reading past the headline, here's what we actually learn. JP Morgan saw its earnings decline by 7.5% year over year and its top line revenue climb back to just above where it was in the third quarter of 2014, two years earlier. And this is the report from the nation's top performing bank. The news at Citibank was no better, with top line revenue falling 4.8 % year over year and profits falling by 5.3%. 

These results confirm a trend of now greater than four years of declining bank revenue and earnings, as previously reported here for 2016 Q2. The major US banks are effectively shrinking, based upon poor top line revenue growth and profitability.

The Trump Campaign Struggles with the Real America

Poor, poor Trump. As successful as he may have been in the business world, he’s clearly out of his league when it comes to Washington. Try as he might, he’ll never be as polished, his record never as scrubbed, his views never as focus-group tested as it takes to win a major election. He’ll fail to cut the back room deals that build support within his own party, fail to carefully cultivate the media that so expertly shapes public opinion, nor will he promise the favors of access sought by powerful special interest donors. 

His campaign will struggle with finances, raising only $94 million by July 1, 2016, versus the $386 million raised by his Democratic opponent. A pathetic $5 million of his funding will come from Super-PACs, compared with the $121 million raised by Hillary Clinton. He won’t get the $1 million donations given each by JP Morgan, Citigroup, Goldman Sachs and Morgan Stanley to Clinton, nor the $1.2 million given by the taxpayer-funded institution, the University of California (note, Obama’s former head of Homeland Security, Janet Napolitano, is now the President of UC). His paltry $2,000 in funding from the hedge fund industry will be dwarfed by the $25 million received by Ms. Clinton’s campaign. He’ll lack the two-faced, deceptive, partisan skills of successful members of the US Congress, a body that now enjoys an approval rating by the American people of just 11%.

In the end, he’ll likely be returned by the electorate to his role as real estate developer, never to amass the 400% gain in personal wealth of Barack Obama during his tenure in the White House, nor the $111 million fortune built by the Clintons through their public service. Washington will go on as it has, an ever escalating arms race of special interest donations, with never a serious effort at campaign reform. We’ll fail to meaningfully attack the federal deficit, perhaps allowing the US national debt to double once again, as it has over the past eight years. We’ll fail to fix social security, disability insurance and medicare, leaving a ticking time bomb at the doorstep of an aging population. We’ll continue to shift the ever-increasing burden of health care costs to middle and upper-middle income consumers, compromising the quality of their health care while devastating disposable incomes. We’ll become even more polarized in our wealth as a society, as we have undeniably become over the past eight years. All the while, Congress’ day to day activities will stall in senseless, immature partisan bickering to form, what President Obama so aptly characterized in 2014 as, “the least productive Congress in modern history.” And, we the American people will be left wondering, is this really all we can expect from government?

No one can defend Trump. All the same, it would be interesting to see someone who thumbs their nose at both the Republican and Democratic parties stumble their way into the White House. Paul Ryan would suffer irritable bowel syndrome for four years. But here's the real concern: a binary political system we Americans have somehow come to accept. If it it's not this, then it's that. If you're not a liberal, then you're a tee-bagger. If you oppose illegal immigration, then you're a racist (by the way, notice the word "illegal" in that sentence). We demonize the opposition. And it's all designed to foster the interests of the two parities who only fein attention to what benefits our country when focus groups show voter support. Once that nonsense is out of the way, the politicians can return to the actual business of government, addressing the concerns of special interests and Super-PACs. Sorry Mr. Trump, but we live in a post-democratic technocracy, where the parties only exist to perpetuate their incumbency.