INSTITUTIONAL INVESTORS

Institutional Investors Knowledge Center

Jan
11
2017

2017 Economic Outlook

In this video, Jim Solloway reviews 2016 and provides our views on the global economy and market outlook for 2017.

SHOW/HIDE TRANSCRIPT

Hello, I’m Jim Solloway, Managing Director and Senior Portfolio Manager in SEI’s Portfolio Strategies Group. Today I will be discussing the potential path of the U.S. markets as 2017 gets underway.

As Donald Trump prepares to become the 45th President of the United States, the world holds its breath. There is so much about him that is unconventional, that it is hard to say where he wants or will be able to take the country in four years’ time. All we can say is that change is coming in many aspects of U.S. policy…economic, social and diplomatic. Dramatic change is made more probable by virtue of Republican majorities in the House and Senate, and Republican dominance in state legislatures and governorships.

The Federal Reserve raised its benchmark rate in December for the second time during this cycle. In similar fashion to the prior year’s hike, the move was anticipated well ahead of time as rates trended higher in the months preceding the announcement. The Fed’s 2017 forecast did change, however, from two anticipated rate increases to three.

Perhaps more so than Fed rate-policy expectations, the U.S. presidential election outcome has put upward pressure on interest-rates. The day after the election witnessed the largest single-day surge in the 10-year U.S. Treasury yield in more than three years. And fiscal stimulus, tax relief, deregulation and less free trade are all on the new administration’s agenda, which will likely foster inflation and keep the upward rate bias intact.

From early July through mid-December rates rose across the Treasury yield curve, and the 10-year yield increased by one full percentage point.

Still, long-term Treasury yields are well below levels that we would associate with having a negative impact on economic growth. In fact, they’re indicative of an improved outlook for growth.

There’s support for that perspective elsewhere in the bond market.

Spreads ? the difference between the yield on a bond and a U.S. Treasury of comparable maturity ? have tightened since early November. They are much tighter than they were in early 2016. This means that investors are demanding less compensation for credit risk. In other words, the likelihood that bond issuers will default has declined in the estimation of the markets. We aren’t just seeing tighter spreads in big safe U.S. corporations; we’re also seeing them in high-yield and emerging-market bonds. The movement in these riskier areas tells us that investor risk appetite has risen.

Tighter spreads also indicate that investors believe economic conditions are becoming increasingly hospitable to companies. Improved conditions mean that companies have greater capacity to service debt.

Our fixed-income managers have been generally short duration as a partial defense against rising rates. Most managers have also added to spread sector positions. Financials, especially banking, have performed particularly well. Already-attractive valuations look even better in light of the incoming administration’s perceived stance on softening some aspects of the Dodd-Frank regulations.

We think the equity bull market ? now the second-longest in U.S. history ? should continue through 2017, with more attractively-valued cyclical and growth sectors leading the way. Corporate earnings, especially in energy, should begin to look better on a year-over-year basis when the first quarter of 2016 rolls off. Lower marginal tax rates and a step-up in equity buybacks should directly boost earnings per share in the year ahead.

Of course, political risks will remain elevated. In the U.S., the new administration in the White House has provided a steady stream of reminders that it will not be restrained by precedent. In the European Union, Great Britain will be seeking to navigate the untested waters of the withdrawal process, while the rest of Europe continues to struggle with slow growth and rising populist sentiment among disaffected electorates.

Thank you and happy new year!