By Stephen Kyne
If there’s a consensus about 2016, it seems to be that it was entirely too long. It wasn’t bad enough that it was a leap year. There was even a “leap second” on Dec. 31.
The year that killed the celebrities we loved just wouldn’t seem to die. Now that it’s over, and Betty White is safe, we can reflect on the year that was and turn an eye toward the new year.
Once again, U.S. GDP grew as expected last year, with annual figures likely to come in somewhere in the 2.1-2.5 percent range, which has been the average growth rate since the recession. We do anticipate potential for increased growth in the coming year as many economic, policy, and regulatory headwinds dissipate. At worst, we expect the same slow growth to continue and expect the likelihood of an imminent recession to be extremely low.
Inflation also increased in 2016, to a rate of almost 2 percent, and we expect this to increase further in 2017. Some inflation, perhaps counter-intuitively, is fundamentally good for the economy. When we expect goods and services to be more expensive tomorrow than they are today, we make purchases today, which means inventories need to be replenished, which puts people to work and gives them money to spend on the things they want and need. Without some inflation, the economy stagnates.
Another driver of spending this year may be interest rates. With the Federal Reserve finally making good on promises to increase the rates they charge banks, we’ll see that increase reflected in higher mortgage rates. The expectation of higher future rates pushes fence-sitting potential buyers into the housing market. As a result we’ve seen, and will likely continue to see, increased sales of new and previously owned homes. The same will likely be true of any purchases which are typically made on credit, including automobiles and business capital items.
An asset class that may be hurt by rising interest rates, however, would be bonds – specifically many bond funds. As newly issued bonds carry higher interest rates, the value of previously issued bonds, with relatively lower interest rates, should decrease.
These changes should be reflected in the overall value of the funds that hold them. A downside of mutual fund investing is that, even though you may watch your values decrease, any gains the funds may have recognized from any of its holdings would be passed on to you. In other words, depending on timing, you can lose money and end up paying taxes for the privilege.
That being said, this is not a call to get out bonds completely. Fixed income investments are an important component of most asset allocations, and typically perform less well as economies improve and stock markets rise. Yet they can act as a ballast when the inevitable downturn occurs.
For the stock markets, 2016 was another very turbulent year. We saw a major correction in the first quarter of the year, followed by hesitant growth as energy prices increased, and the election cycle ground on. Surprises like Brexit and the U.S. election threatened to derail the whole thing yet, so far, have had no negative impact. Understandably, many investors are still wary of both events. The effects will begin to be felt in the coming year.
For the U.S. stock markets, we think 2017 should be a profitable year, with returns easily in the 10 percent range, although that bullishness must be qualified as we weigh President Trump’s ability to deliver on his promises to decrease corporate taxes, reduce inhibitive regulation and reform prohibitive policies. If he is able to work with Congress and deliver, even moderate reforms, the economy should continue to respond well.
Specifically, we feel there is opportunity in small and mid-sized U.S. companies in the coming year, for several reasons. These companies tend to operate domestically, and would likely be less impacted by international strife, including increased populist sentiment which may result in unexpected election outcomes in France and Germany, as well as any unexpected side effects of the march toward Brexit.
Additionally, these companies are less likely to be impacted by any retaliatory tariffs, if the new president makes good on some of his more isolationist rhetoric. Thirdly, the value of the U.S. dollar has increased substantially relative to other currencies, making U.S. exports relatively more expensive, even without tariffs, which should have a more limited impact on companies operating largely within the U.S.
Internationally, we expect more of the same: countries doing well should continue to do so, those in trouble are unlikely to see much relief.
While we don’t believe the EU will dissolve, we do expect there is enough political uncertainty in the region to hamper growth. Between populist uprisings in the election booth, refugees from the Middle East, and economic uncertainty caused by poor public policy and pending trade negotiations with the UK, we feel there is reason to be cautious when investing in Europe, although we do not expect an outright recession.
With the exception of some of the smaller Southeast Asian nations, we are not overly optimistic about emerging market economies. The situation in many of the Latin American nations continues to erode. Growth in China continues to slow. Russia will be an interesting economy to watch, as relations with the U.S. may change markedly with foreign policy adjustments likely to be made by President Trump.
From a fundamental standpoint, we believe the U.S. is the most advantageous place to be invested for growth. If changes promised by the new U.S. administration come to fruition, American companies, their employees, and shareholders stand to be the biggest winners.
That being said, these are forward-looking statement, any number of domestic and international events could drastically alter this outlook. Be sure to work closely with your independent advisor to help ensure your investment strategy accurately reflects your goals and any changes in the economic landscape.