5 January 2017 Business Wire
For nearly 30 years, Doll’s widely followed annual predictions have taken a comprehensive look at the trends and issues he believes are positioned to meaningfully shape the economy and markets for the coming year. They further lay the foundation for the noteworthy portfolios he and his team run in the Nuveen Large Cap Equity Series. Doll’s Ten Predictions have long served as a thoughtful guide to issues investors should consider as they work with their financial advisors to build strong long-term investment portfolios.
A Look Back at 2016
2016 was a year marked by equity market volatility. The first quarter alone saw a U.S. stock market decline and rebound of more than 10% each. Stocks experienced a sharp drop and quick rebound following the Brexit vote, and S&P 500 futures fell almost 5% immediately following Donald Trump’s election before rising on the following trading day. Improving investor sentiment following the election boosted equity prices, but better fundamentals (chiefly an accelerating economy and rebounding corporate earnings) also played a big role rising equity prices. With the annual advance, U.S. equities notched an unprecedented eighth consecutive year of gains, with the S&P500 Index experiencing an impressive total return of 12.0%.
Perhaps more important than the broad market performance were the significant changes that occurred in market leadership last year. In the first half of 2016, as investors remained concerned about economic growth and lingering deflation fears, they pursued relative safety, sought out growth and focused on defensive, yield generating areas of the market. That began to change in the second half of 2016 as smaller capitalization, value and cyclical sectors outperformed — and those changes accelerated sharply after the U.S. election. This shift was strong enough that, for the year as a whole, small caps dramatically outperformed and value easily surpassed growth.
Outside of the United States, many markets continued to struggle. Relatively slower growth and very low (and, in some cases, negative) rates of inflation hampered many economies. European markets struggled to post gains in this environment (and the Brexit vote didn’t help matters). Chinese stocks plummeted dramatically at the start of the year, and while share prices rose between February and year-end, the initial drop caused Chinese equities to end the year in the red.
In contrast to stocks, bond markets struggled in the closing months of 2016. The yield on the 10-year Treasury rose more than 100 basis points in the second half of the year, and we believe the bull market in U.S. Treasuries that started in 1981 has ended.
Set against this backdrop, Doll presents his Ten Predictions 2017, followed by his 2016 Scorecard, and also offers a guide for investors for the year ahead.
2017 Ten Predictions
1 U.S. and global economic growth improves modestly as the dollar strengthens and reaches parity with the euro.
Correctly forecasting economic growth for the coming year looks to be more difficult than usual. The aging business cycle, rising interest rates, climbing dollar and continued slow productivity growth all create formidable headwinds. On the positive side, the recent election has unleashed a significant increase in consumer and business confidence. We forecast another relatively modest year of growth in 2017, somewhere around 2% real GDP growth. We also expect the dollar to exhibit further strength and reach parity with the euro sometime in 2017.
2 Unemployment drops to its lowest level in 17 years as wages increase at the fastest pace since the Great Recession.
2016 was a strong year for jobs growth: Average monthly new jobs averaged approximately 185,000. We think the average will remain above 150,000 in 2017. The current 4.6% unemployment rate could drop further next year to below the 4.4% rate reached in May 2007. Average hourly earnings growth bottomed at below 2% two years ago and could exceed the 3.1% level they hit in June 2009. We are also watching to see if the participation rate experiences a cyclical pickup.
3 Treasury yields move higher for a third consecutive year for the first time in 36 years as the Fed raises rates at least twice.
We have clearly reached an inflection point with the Fed and with interest rates more generally. The 10-year Treasury yield peaked at 15.84% on September 30, 1981, then declined irregularly to 1.37% on July 8, 2016. We think this low marked the end of a 35-year bull market in bonds. The final chapter of that bull market involved the Fed moving the fed funds rate to the “emergency” level of zero during the Great Recession. Since then, attempts at reflation in the U.S. and globally have been mixed, but finally seem to be working. As 2016 drew to a close, the Fed pointed to multiple rate increases in 2017 and 2018.
4 Stocks hit their 2017 highs in the first half of the year as earnings rise but price/earnings multiples fall.
As with our economic forecasts, our stock market prognostications for 2017 are tougher to make than usual. The post-election “animal spirits” environment has buoyed the stock market. Possibly more important, the market surge has also been driven by improving economic indicators since October. While we expect pro-growth measures to be passed in 2017, we see two caveats. First, passing them will not be as easy as the current euphoria suggests. And they are unlikely to take effect until January 1, 2018. Couple this with a slow but likely increase in inflation, and we think a tug of war between rising earnings expectations and eventual valuation (P/E multiple) deterioration will suppress equity prices. As a result, we may witness the 2017 high in stock prices in the first half of this year.
5 Stocks outperform bonds for the sixth year in a row for the first time in 20 years while volatility rises.
It hasn’t happened in two decades, but we think stocks will beat bonds for six years in a row. For much of 2016 before the year-end rally, stocks yielded more than bonds. This highlights both the overvaluation of Treasuries and the undervaluation of stocks relative to bonds. In our experience, it is not uncommon to see stocks outperform bonds with stocks rising and bonds falling in the latter stages of a bull market. If real and nominal growth increase, it will likely be a difficult environment for fixed income. But it could also be favorable for equities. We also expect volatility in both asset classes to rise.
6 Small caps, cyclical sectors and value styles beat large caps, defensive and growth areas.
This prediction would be easier if the rally in small caps, cyclicals and value stocks that began in the second half of 2016 and accelerated after the election hadn’t been so strong. But we expect these trends will continue despite the gains. After a period of noticeable underperformance, small cap stocks have begun to beat large cap stocks due to the rise in the dollar, expected tax changes and weakening global trade. Cyclicals should beat defensives as growth accelerates and income oriented stocks continue to underperform. Valuation for cyclicals is supportive as well. Finally, value over growth (which is positively correlated to cyclicals over defensives) should occur as growth accelerates and inflation rises.
7 The financials, health care and information technology sectors outperform energy, utilities and materials.
Financials have been the leader since the election and should benefit from regulatory easing in 2017. Financials also feature cheap valuations. Health care presents a good opportunity beyond headline risks, and information technology offers both good growth and value characteristics. Conversely, we continue to believe global growth will not provide the pricing power necessary for energy and materials to shine. Finally, utilities represent the intersection of yield, perceived safety and low volatility — a combination that has underperformed recently and may continue to do so.
8 Active managers’ performance improves as flows into equities rise.
The period of extended significant inflows into bond funds and outflows out of equity funds may be ending. Improvements in nominal growth argue for a reversal and relative valuations also look supportive. Investors have experienced an unusual confluence of events — slow growth, deflation, macro-dominated markets, falling interest rates and high correlations within and across asset classes — that are likely fading, if not reversing. Active equity managers have struggled in recent years, but perhaps the stars are finally aligning for a long-awaited reversal in this trend.
9 Nationalist and protectionist trends rise as pro-domestic policies are pursued globally.
The 2016 global political environment was marked by a rejection of establishment policies and a rise in nationalism, protectionism and isolationism. The Brexit vote, the Trump election and the Italian referendum all symbolize this shift and point to a world in which many countries are withdrawing from the global economy. In general, we believe more globalization and more trade are healthy for global GDP growth, so moves in the opposite direction are worrisome. This issue won’t be decided in one calendar year, but should be monitored carefully.
10 Initial optimism about the Trump agenda fades in light of slow legislative progress.
Optimism surrounding the Trump agenda is high, as investors are expecting tax reform, increased infrastructure and military spending and a rollback of regulations. While we believe fundamental change is on the way, it may not be as easy as it appears. In particular, such comprehensive legislation is rarely simply crafted and passed without significant revision. Secondly, most of the contemplated agenda is likely to be passed in 2017, but won’t take effect until 2018. Additionally, the mood of the markets may sour if Donald Trump’s protectionist rhetoric (largely absent from post-election proceedings) resurfaces.
Bob Doll Scores His 2016 Predictions
1 U.S. real GDP remains below 3% and nominal GDP below 5% for an unprecedented tenth year in a row.
2 U.S. Treasury rates rise for a second year, but high yield spreads fall.
3 S&P 500 earnings make limited headway as consumer spending advances are partially offset by oil, the dollar and wage rates.
4 For the first time in almost 40 years, U.S. equities experience a single-digit percentage change for the second year in a row.
5 Stocks outperform bonds for the fifth consecutive year.
6 Non-U.S. equities outperform domestic equities, while non-U.S. fixed income outperforms domestic fixed income.
7 Information technology, financials and telecommunication services outperform energy, materials and utilities.
8 Geopolitics, terrorism and cyberattacks continue to haunt investors but have little market impact.
9 The federal budget deficit rises in dollars and as a percentage of GDP for the first time in seven years.
10 Republicans retain the House and the Senate and capture the White House.
Score: 8.5 out of 10
Outlook 2017: A Difficult Investing Environment Requires Selectivity
We are moderately constructive on the outlook for the U.S. and global economies and for risk assets in 2017.
We expect a shift from an environment of secular stagnation and deflation fears to one marked by somewhat stronger growth, higher inflation and rising interest rates. It may be premature to bet aggressively on a full-fledged growth pickup, but recognizing the reduced probability of the downside economic risks that have dominated since the end of the financial crisis represents a significant change.
At the same time, we recognize that 2017 will also likely produce a high degree of uncertainty. The election of Donald Trump may usher in significant changes to tax, trade, immigration and regulatory policies. To date, investors have been banking that the Trump administration will focus on pro-growth policies, but the possibility of more protectionist overtones in the United States brings with it some worries.
Additionally, a combination of a tighter labor market and more fiscal stimulus should lead to higher wage inflation. With the Fed slowly retreating from its policy of emergency rates, interest rates will likely rise. When that happens, investors must determine whether an equity bull market that has been driven by liquidity can continue as one driven by revenue and profit growth. We expect the improving economy and likely corporate tax reform to help boost corporate earnings, but a stronger dollar and rising rates may counterbalance these positives.
In this environment, investors may be in for a difficult ride. The 35-year disinflationary, falling interest rate world is ending, and that brings some challenges. We think investors should expect more modest, single-digit returns over the next 5 to 10 years from nearly all asset classes due to relatively slow long-term global economic and earnings growth and generally full valuations.
We expect the investing environment will be driven less by broad macro issues and more by security-specific fundamentals. We forecast several investment themes: stocks over bonds, small caps over large caps, value over growth, cyclical sectors over defensive ones and credit sectors over government bonds. More critically, we think making the right portfolio decisions will require a focus on individual security selection to generate outperformance in all asset classes.
Key Themes for Investors: Matching Goals to Investments
Early in the year is often a time to review investment goals and adjust asset allocation decisions with your financial advisor. We suggest focusing on the following areas as you assess your portfolio:
Maintain an overweight in equities, but be selective:
Equity markets will continue to struggle, but should outperform bonds and cash in 2017. Gains will likely be narrower and more focused on specific companies and investment styles, so selectivity will be crucial. We continue to focus on companies that generate free cash flow and have a preference for smaller capitalization and cyclical areas of the market.
The shift in equity market leadership is likely to persist:
In mid-2016, we began seeing a move away from defensive and yield-oriented areas and toward value and economically cyclical parts of the market. As growth and inflation increase in 2017, we think these trends will continue.
Selectivity also matters in fixed income:
With low yields and the prospect of modestly rising rates, fixed income investing has become more challenging. Investors may want to rely on active managers with the flexibility to respond to market changes and the investment acumen to remain ahead of their peers in uncertain markets. We think focusing on credit sectors (including high yield) over government-related sectors makes sense, and we also see value in municipal bonds.
Alternatives can play multiple portfolio roles:
Alternative assets, including real assets, real estate and other investments, may provide a portfolio with diversified sources of risk, return and/or income. Alternative strategies such as equity long/short or market neutral have a low historical correlation to long-only, benchmark oriented investments.
Characteristics we look for when evaluating companies:
▪ Free cash flow can provide flexibility to raise dividends, buy back shares and reinvest in the business
▪ Companies with the ability to generate unit growth may be advantaged over those that lack pricing power
▪ Economic sensitivity and above-average secular growth may help insulate against market fluctuations
The opinions expressed by the author are for informational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. These views may differ from other investment professionals at Nuveen Investments and are not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any time period. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment grade bonds involve heightened credit risk, liquidity risk, and potential for default. An investment in any municipal portfolio should be made with an understanding of the risks involved in investing in municipal bonds, such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. Clients should contact their tax advisor regarding the suitability of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets.
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