As with any new annual market forecast, it’s always nice to review the prior one provided. Here’s a quick recap of my top four capital market forecasts for 2016:
(a) 10-Year US Treasury = 3.16%
(b) Euro/ US Dollar Exchange Rate = 1.061
(c) West Texas Intermediate Crude = $47.50
(d) Dow Jones Industrial Average +12.98%
My forecasts were fairly accurate, in particular the EUR/USD exchange rate (actual = 1.052), Crude Oil (actual = 53.72), and the total return performance of the DJIA (actual = 16.50%). I overestimated the Federal Reserve’s agenda to more diligently raise rates, as the actual 2016 year-end 10-Year Treasury rate was 2.445%, 71bps lower than my forecast. For all the gold bugs out there, my gold (per ounce) forecast was $1,312.00, although spot gold did meet and briefly surpass this level post-Brexit, it ended the year at $1,145.90.
Turning our attention to the year ahead, I believe there are two themes that will dominate our global capital markets Politics and Central Bankers. First, the political tailwinds driven by populist movements in the US, U.K., and Europe will devolve further into policies that impact trade agreements and result in currency wars. A strong US dollar stance, held universally by Federal Reserve leadership, will begin to soften in the face of continued declines in US industrial output (see chart below) and the resulting US export pressures.
I expect US Dollar and Euro parity at some point this year, especially prior to or around the time of the French presidential election on April 23rd. The Japanese yen should continue to weaken further into the 130 range. Populist political agendas will make for innovative trade agreements between the US and UK, in an effort to go head-to-head with the last year’s Canada/Europe deal. This is all very good for global trade, as fierce competition forces efficiencies, productivity, and corporate earnings growth. Speaking of corporate earnings, expect to see US equity valuations to take a breather as the new Trump administration faces a challenge implementing their corporate tax reform.
In the end, the corporate tax rate will be modified and become more globally competitive, which will help justify current US equity valuations that have already priced this in. Deregulation and corporate cash repatriation are both major positives on US equities valuations, should they come to pass in 2017, which is doubtful. Earnings growth will need another support (not just tax cuts) to keep the Bull Run going, however. This means that recent labor productivity improvements must keep up the trend. Non-US stocks in both developed and emerging markets will benefit from a slightly weakened dollar, as capital investments elsewhere find favor on a currency exchange basis.
The second big theme for 2017 will be the pace of the US Federal Reserve stuffing the monetary stimulus genie back into the bottle. After years of ultra-accommodative monetary policy, both in the US and abroad, better economic growth will quickly result in higher than desired inflation throughout all sectors of the economy. The Fed will want to get out ahead of this headwind to maintain some semblance of inflationary control. Meanwhile, managing the Federal Reserve’s balance sheet to historically normalized levels means considering their going to need to sell some assets off, instead of continuing the current practice of allowing assets to roll off due to maturation or being called away. Regardless, this task is Herculean (see chart below) and unprecedented, two of my least favorite words when describing economic matters.
SUMMARY: My 2017 forecast using the Good – Fair – Bad scale: US Stocks – Good, Non-US Stocks – Fair, Bonds/Fixed Income – Bad, Oil – Good, Gold – Fair, Large Cap stocks – Fair, Small/Mid Cap stocks – Good. (Note: DJIA was 16,153.64 on 2/2/16, date from which 2016 performance forecast was based. All forecasted values are on record with CFA Society, Los Angeles – 2016 Economic Forecast Ballot, submitted on February 2, 2016.)