Q4 2016 Newsletter

We believe 2016 will best be remembered for two themes: First, World Central Bank’s dogmatic focus on pushing bond yields lower (and negative in some situations), and second, the anti-establishment sentiment which led to Britain voting to leave the European Union and to the election of Donald Trump in the United States.

However, there is an underlying story which is often overlooked. Throughout 2016, Leading Economic Indicators (LEIs) increased. Picking up from our October newsletter, we believe 2017 is gearing up to be a good year for the U.S. economy. We expect LEIs will continue moving higher along with rising corporate profits. What started in 2016 will likely continue into 2017, and typically means positive things for the economy and the stock market. The economic recovery happening in the U.S. is also being experienced internationally, where we see increasing economic conditions abroad.

A potential headwind to this assessment is the Federal Reserve and its anticipated interest rate hikes. We believe the pace and number of interest rate hikes could be more than the market expects based on early readings of the economic data, and the fastest pace of wage inflation since 2008.

Another wild card is the possibility of fiscal stimulus planned by the Trump administration. In reviewing research from JP Morgan, it was demonstrated that federal government direct purchasing of goods and services (including infrastructure spending), typically has a much greater impact on Gross Domestic Product than do corporate tax cuts, according to the Congressional Budget Office. Another major shift under Trump will be deregulation, especially in the healthcare, financial, and energy sectors. There are potentially other issues, including the strength of the U.S. dollar and corporate tax reform, which I will not reference for brevity’s sake. The signs are pointing to an economic recovery which is the result of more than just monetary or fiscal stimulus.

In a nutshell, with continued economic growth, we expect to see market gains in 2017. However, near-term volatility could increase due to the uncertainty surrounding future interest rate hikes. Because of inflationary pressures, we also expect to see intermediate and long-term bond yields rise. Despite the expected increase in rates, quality fixed income remains in a low return environment and should be negatively impacted by rising rates. We started making adjustments to fixed income in 2015 in anticipation of the changing landscape. We made further changes in 2016 and expect additional changes in 2017.

Best Regards,
Marc Henn CFP ®, President

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