What a difference a year can make. After two years of lackluster returns for diversified portfolios, 2016 started off with the worst open ever for the Dow, a whopping 10% drop in the first 10 days of January. A few months later, markets swooned and then quickly recovered after the “Brexit Crisis.”
Through it all I advised clients to recognize the underlying economy was still slowly growing, and to stay the course in well-diversified portfolios designed around their risk tolerance and financial goals. Keep the sails up. At some point, the markets winds would kick in.
And when we least expected it the cool breeze began blowing and markets took off, rising to record highs after the election. By the end of the year the S&P 500 Index had risen by 12%, including reinvested dividends, according to Morningstar. And for the past month they have been relatively calm holding within 250 points of the recent highs.
Now the question on many investors’ minds: will the rally hold? Going forward, there is one thing I can promise you—we will run into another round of volatility. That is a natural part of the market’s progress. But are we in for a major pullback? Let’s look at the possibilities.
Looking ahead
On the positive side, the year is starting in an upbeat fashion. The economy is moving ahead at a modest pace, interest rates remain low, and odds of a recession are low.
Moreover, Thomson Reuters forecasts S&P 500 profit growth of 12.5% this year, and consumer and small business confidence is up sharply in wake of the election (Conference Board, National Federation of Independent Business).
However, the economic skies are never fully clear. For starters, the forecast for corporate profits is predicated, among other things, on continued economic growth. And markets currently appear to be a bit ahead of where they should be relative to the economy and corporate earnings.
The late-year optimism that pushed the major indexes to new highs was aided by optimism that tax reform, regulatory relief, and infrastructure spending are on their way. But what shape will tax reform and new spending take? Compromises will be needed and major new spending, if it passes the Republican Congress, could have huge lead times.
Thankfully, Donald Trump has toned down his anti-free-trade rhetoric, alleviating some worries among investors. And his tough talk on trade may just be bluster, as he hopes to strike tough new trade deals. But what if a miscalculation sparks a trade war? We know from the past that a breakdown in global trade can have serious consequences.
Summary
So, as always, there is both downside risk and upside potential. With markets more than fully valued, however, the upside potential seems limited for the near term. Barring any major outside event or political mis-step, then, the most likely scenarios for 2017 seem to be either 1) a relatively benign pullback to more reasonable market valuations before turning back up, or 2) a bumpy, sideways market until the economy catches up and moves the markets forward again. In the end, I expect 2017 to finish slightly higher.
Of course, the market can always surprise us, and usually does, one way or another! We keep our fingers crossed that our new president will rely on his strengths and not his weaknesses. And at some point the market will surprise us with another cool breeze. So, we remain with our sails up in expectation and an eye on the skies. Happy sailing to you in 2017.
If you would like to discuss this article, please call me at 316-440-2550
Gregory A. Carr, MBA, AAMS®
Owner, Financial Advisor
A Mission to Serve. Advice You Can Trust.
