Chief investment officer, LPL Financial
The economic outlook for 2017 largely depends on what policies president-elect Donald Trump decides to pursue, according to LPL Financial CIO Burt White.
‘On the one hand we could get policies that look a lot like [Ronald] Reagan: lower taxes, lower regulation and infrastructure spending. On the other [you could] think of this like the Smoot-Hawley years in the 1930s, when there was trade isolationism and trade wars.
‘Those are the bookends, and you could drive a truck through that.’
White believes the US is more likely to see something akin to the Reagan years, with tax cuts and infrastructure spending boosting GDP growth, which in turn will be reflected in equity markets.
He tipped US earnings to continue to recover in 2017, having ended their recession at the end of 2016.
‘We don’t think you are going to get a lot of margin expansion. Most of your increase will come from pure earnings growth. [In 2016] we ended the earnings recession… and saw decent growth of 3-4%. We think this year we will see it in the 6% to 10% range, which will be pretty good.’
He acknowledged that valuations were ‘a little stretched’ but argued the equity bull market had further to run.
‘We are not over-borrowing, we are not overspending, we are not over-building, we are not over anything. So a rule of thumb for me is that until you see “overs” the bull market isn’t over,’ he said.
He highlighted the impact Trump’s campaign talk had already had on some industries, and said sector allocation could hold the key to outperforming in 2017.
‘Overweight versus underweight equities might not be the play this year, but what you are doing underneath at the sector level might be really interesting. We are having a lot of dialogue with our managers about that,’ he said.
He tipped financials, energy and building material stocks to benefit most from a ‘Trump rotation,’ while stocks that are interest rate sensitive, such as Reits, utilities and consumer staples, might fare worse.
Outside of the US, White said he was looking to add some exposure to developed market and emerging market funds, although in the case of the former this would be from a very low weighting currently.
‘We have been at virtually zero weight for four or five years now,’ he said. ‘We are starting to see valuations look OK there, but there is a lot of hard sledging to be done in Europe. We are continuing to be underweight, we are just going to begin to close our underweight gap.
‘Emerging markets earning expectations are at 15%. Even if that is off by a little bit you are still looking at double-digit earnings growth there, which is still pretty good.’
Turning to fixed income, White predicted the Federal Reserve would raise rates twice in 2017, and that based on this bonds would post low-single-digit returns, with credit and high yield doing a little better than Treasuries.
He added that Trump’s planned tax cuts and infrastructure spend could see the popularity of municipal bond funds suffer.
‘We continue to be constructive on municipal bonds, but you could see better opportunities especially on the credit side of the business,’ he said.
While alternative strategies may not have had their best year in 2016, White said global macro and managed futures managers could add value in 2017.
‘You will have an interesting push and pull between economic growth and inflation moving higher, but also the dollar moving higher. It will be interesting to look at how that affects currencies,’ he said.
He added that a rising rate environment meant investors would likely look away from bonds for volatility control, which would boost flows to alternatives.
‘It means we are finally going to start to see the value in alternatives once again. It has not been a great place to be because of how strong equities and bonds have been over the last eight years.’
Chief investment officer, Dynasty Financial Partners
The market reaction since the US election has been overdone, according to Dynasty CIO Scott Welch, who believes returns next year from public markets will continue to be muted.
‘The issue really is that no one really knows what is going to happen, so in our opinion the global economy remains relatively benign,’ he said.
‘We seem to have crawled out of the deflationary spiral. There is a lot of geopolitical fragility, particularly in Europe, and this global populist movement, which is a big unknown.
‘When you combine all those factors together our outlook is for a continuation of relatively muted returns in most of the public markets, at least at the index level, individual sectors might do better.’
Welch is perhaps less confident on US equities than some, due in part to uncertainty over which policies Trump will actually pursue and also due to concerns over valuations.
‘Everyone is trading right now in anticipation of him [Trump] behaving a certain way, but I don’t think there’s any certainty that he will behave a certain way,’ he said.
‘We thought valuations were stretched before the election, and that a big chunk of what was driving those valuations was low interest rates, and if rates go up you are applying a discount rate to future earnings.’
He acknowledged that there may be tailwinds to improve valuations such as Trump’s plans to encourage corporations to repatriate money held overseas, but again highlighted policy uncertainty as a cause for skepticism.
‘We may be out of the consensus on this,’ he said. ‘I attended a conference with 15 CIOs and probably 50% of people agreed with my view and 50% thought the markets are going to do just great next year. It all depends how you interpret what is going to happen under a Trump administration.’
Welch believes investors also overreacted after the election by selling off emerging markets, and that these are still a good bet long term provided investors are willing to endure some volatility.
‘It may have been oversold after the election,’ he said. ‘Long term we still think emerging markets are a very good place to be. In the short term it can be very affected by investor sentiment. We like emerging markets long term, but investors need to accept the volatility that goes along with it.’
‘The fixed income market in particular, at least the duration strategies, look at little fragile,’ Welch said. ‘We are not overly constructive on interest rates and therefore on core fixed income. There may be some more opportunities in unconstrained credit strategies.’
He suggested the shift towards a rising-rate environment would mean bonds would no longer offer the protection many investors had used them for and suggested alternative assets could instead provide that portfolio hedge.
‘It’s not that I think bonds are bad. The credit quality is still good, but there is some price risk and people just may not get the kind of portfolio protection from bonds that they are used to. People should not abandon them, they just may want to add other things in that have less correlation to either stocks or bonds.’
Welch was most positive on alternative investments.
‘Generally, we think the best opportunities over the next couple of years are going to be the private markets,’ he said. ‘Private equity and especially private debt. If you have investors who can tolerate that kind of illiquidity then that would be a pretty good place to look next year.
‘We have allocations to equity long/short, we have allocations to event driven and market neutral, relative value strategies.
'We like global macro and managed futures. Even though they haven’t had a great year this year we remain solid on them as part of a diversified portfolio.’
Chief investment officer, Commonwealth Financial
While value stocks have outperformed their growth counterparts in 2016, Brad McMillan, CIO of Commonwealth Financial, believes this will change again in 2017 as companies reinvest.
‘I think you are going to see companies really starting to invest and grow again, and that’s going to be rewarded with higher multiples in that space,’ he said.
While McMillan argued the biggest risk to US stocks remains political, particularly that Trump and Congress may not agree on policies, he was positive on a number of parts of the market, specifically financials, consumer discretionary as well as domestically focused mid-cap companies.
He predicted high-single- or low-double-digit growth from the US equity market over the next 12 months.
‘We’ve seen a substantial bump there, but I think that there’s more to be gained, he said.
One area of concern McMillan flagged was the current valuation of small-cap companies.
‘It think that you can make a case for it but right now, I’m not sure if it’s the best place from a valuation standpoint,’ he said.
McMillan said developed market equities were looking cheap, especially compared with US stocks, but could suffer if exports to the US fell or political upheaval struck.
He said Germany in particular was dependent on exports to the US, which could take a hit if Trump followed through on rhetoric around restricting international trade, and highlighted possible political fallout in France, Germany and the Netherlands next year.
‘There is more political risk than economic risk, but the flipside to that is that we’ve had political turmoil in Europe for years, and yet things continue to get better. So, I think there some opportunities in the developed space,’ he said.
McMillan argued that emerging markets were likely to perform better than expected despite the recent sell-off and current negative sentiment.
‘What else can go wrong?’ he said. ‘In terms of the strong dollar, in terms the potential Trump trade agenda, in terms of fears about China, yes, things could get worse. But chances are it will be better than people expect. Things aren’t nearly as bad as they look.’
He said the Indian government’s recent crackdown on counterfeit money and the black market was a positive step in a country with strong potential for growth. He also highlighted Brazilian and Russian stocks as being cheap right now, but was skeptical of some of their fundamentals.
‘This is not quite a lottery ticket but, in certain cases, a higher-risk investment,’ he said.
Within fixed income, McMillan said he liked credit and corporate debt as opposed to sovereign debt in a rising rate environment.
‘If you are looking at interest rates, you’re simply not getting enough in the way of pure coupon payments to justify the risk,’ he said.
‘You have to keep your duration short and you have to focus on credit… the problem is that a lot of people know that, and high yield spreads have come down considerably, so it will require fairly careful navigation.’
He tipped the Fed to raise rate three times in 2017. ‘It’s really not a question of the economics of it – I think you can justify four – but it’s a question of how panicked the Fed gets with inflation,’ he said.
‘The Fed has a history of waiting too long every single time and then hustling up, but the question will be: will they panic in the beginning of the year or the end? I think they will at the end of the year.’
He said movement in the municipal bond space would depend on what tax cuts Trump actually delivers.
‘I do expect that to happen, but a lot of the devil will be in the detail, like exactly how many deductions will be allowed and exactly how it plays out in different income levels,’ he said.
Director, Research, Boston Private
The recent rally in equity markets is not simply a result of election-inspired confidence, but a reflection of underlying trends that have been exacerbated by Trump’s win, according to Bryan Keller, director, research at Boston Private.
‘People are mistaken to think that recent market action is a result of the election,’ he said.
He believes the economy is in a good position and that this could keep the rally going for longer than expected.
‘The US consumer is still strong: housing demand is doing well, wages are picking up and consumer credit is good. Therefore, there is a lot of capital floating around that needs to find a home, and that could drive the rally higher.’
‘There’s a good chance the rally could continue into next year as investors start getting their year-end statements and see that risk-off investments (bonds, safety stocks, real estate, utilities) have been crushed. They might start chasing performance, switching focus from bonds to stocks,’ he said.
He said investors may not make decisions based on valuations, but instead will keep chasing returns.
‘Nobody is paying attention to human behavior – “animal spirits.”
'Greedy performance chasing is a characteristic of the last gasp of a bull market cycle, and not something that we’ve seen until recently. And it could go on longer than you think,’ he said.
He tipped financials to continue their recent run as a result of decent fundamentals and valuations, but argued consumer staples, utilities and Reits all looked expensive.
Keller highlighted the recent positive performance of small-cap stocks, which he said could benefit from Trump’s planned corporate tax cut.
‘We’ve seen a massive run for small-cap stocks: small cap is up 22%, small-cap value is up 32%. We aren’t chasing small caps here, but given their domestic exposure, and being the prime beneficiary of potential corporate tax reduction, they could continue to perform positively,’ he said.
‘While out of favor right now, looking forward, international [equities] may be a good place to earn higher returns. 'Relative valuations are cheaper, and international stocks are earlier in their stage of the recovery,’ he said.
Keller said all eyes would be on the Fed on 2017, but argued investors should not panic about a rising rate environment. ‘People worry about bonds in rising rate environments, but drawdowns should be limited over the long term,’ he said. ‘If you’ve invested in shorter-duration, high-quality bonds and you hold on drawdowns are going to be less.
‘You’ll see lower returns, but they will occur over a shorter period time. In fact, if you look at the returns on 10-year treasuries from the time yields bottomed in the early-1940s until they peaked in the early-1980s, the worst annual loss was just -2.10%.’