Capital Market Outlook for 2017

January 20, 2017

Capital Market Outlook for 2017 Photo

Nearly eight years into one of the most unloved bull markets ever for U.S. equities and credit, the rally now appears ready for “extra innings.”  Despite increasingly full valuations and an earnings recession for U.S. companies during a recent five-quarter stretch, proposed economic policies under the Trump administration will be supportive of domestic economic growth and corporate profits. The awakening of dormant “animal spirits” should provide a boost to both business and consumer confidence and finally move the economy out of stall speed. Corporate profitability will once again be defined by fundamental yardsticks (i.e. sales growth, margins), as opposed to financial engineering fueled by low borrowing costs.

While supportive of risk markets, Trump’s policies will likely spell the end of the 30-year bull market for bonds. Protectionist trade policies, tighter labor market conditions and accommodative monetary policy will push inflation readings above the Federal Reserve (Fed)'s 2% target next year and take interest rates higher alongside. In line with recent Federal Open Market Committee (FOMC) projections (the so-called “dot plots”), we anticipate three quarter-point rate increases this year by the Fed. Long-term Treasury rates will maintain their upward trajectory experienced since Election Day, with the 10-year Treasury projected to finish 2017 near 3%.

We entered 2016 with the view that credit risk premiums were attractive relative to equities. Even our optimistic projections did not foresee high yield bond performance in excess of 17% for the 2016 one-year period. Investment-grade corporate credit also performed well in 2016, outperforming duration-matched Treasury bonds by nearly 5%. Corporate credit spreads overall have now reached fair value territory but pockets of opportunity still exist for active management. Credit selection, yield curve positioning and tactical exposure versus government debt will be necessary to realize significant outperformance in 2017.

This year will be the year equity investors transition back to basics as sales and earnings growth drive performance. Since the financial crisis, the low interest rate environment has incentivized U.S. corporations to borrow and use the proceeds on financial engineering (primarily in the form of share repurchase activity). More than two-thirds of total S&P 500 corporate earnings have been spent on share buybacks during the past year. Incredibly, 119 S&P 500 companies* have spent more on buybacks than they generated in earnings. Proposed Trump policies for fiscal stimulus, a less restrictive regulatory environment and elimination of the tax deduction for interest expense will shift incentives back toward new capital investment. We expect greater dispersion among equity market winners and losers in the new environment, but moderate gains for the U.S. equity markets overall.

*Information from FactSet

Exhibit 1: 2016 Actuals and 2017 and 2018 Forecasts

To see our 2016 market and economic year-in-review, please click here. Check back to the blog weekly for more updates on our market outlook and investment ideas.

S&P 500 Index – An index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe.

Russell 2000 Index – An index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks.

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Disclosures:

The views expressed in this material are the views of PMAM through the year ending December 31, 2016, and are subject to change based on market and other conditions. This material contains certain views that may be deemed forward-looking statements. The inclusion of projections or forecasts should not be regarded as an indication that PMAM considers the forecasts to be reliable predictors of future events. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate. Actual results may differ significantly.

Past performance is not indicative of future results. The views expressed do not constitute investment advice and should not be construed as a recommendation to purchase or sell securities. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed. There is no representation or warranty as to the accuracy of the information and PMAM shall have no liability for decisions based upon such information.

Tags: Viewpoints | Bonds | Stocks | U.S. economy | Federal Reserve | Commodity prices

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The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice.  The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete.  Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements.  Actual results may differ significantly.  Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.

Investing involves risk, including possible loss of principal.  Past performance is no guarantee of future results.  All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.

High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.

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