From the January 2017 issue of Investment Advisor • Subscribe!

2017 Markets: The Great Unknown

Our fearless forecasters share the highs, lows — and their worries — about 2017’s markets and economy

One forecast our Asset Allocation panelists agree on: the interest in index investing won't go away in 2017. One forecast our Asset Allocation panelists agree on: the interest in index investing won't go away in 2017.

We head into 2017 facing a great deal of uncertainty. The Department of Labor’s fiduciary rule, finally released in April 2016 after six long years of theorizing what it could hold for advisors, is once again an unknown entity as policymakers and industry organizations continue their fight to delay or dismantle it. President-elect Donald Trump, who will take office Jan. 20, 2017, with a Republican majority in Congress, is untested as a politician, and his mercurial public persona makes it difficult to predict how he will finally act on issues that are important to advisors and their clients.

Washington Bureau Chief Melanie Waddell breaks down some of these political and regulatory uncertainties in the cover story beginning on page 20. To attempt to divine how these factors might influence the economy, we turned to our monthly Asset Allocation panelists.

Each month, we ask our panelists to provide their financial and economic outlooks for the next six months, as well as their recommended portfolio allocations. This month, we asked them to expand these outlooks to all of 2017, and to share their top concerns for investors and for the economy.

Politics: Fears of Populism

The new political environment can’t be untangled from the markets.

Continued trouble in the eurozone and the global rise of populism are the top two geopolitical concerns for Brad McMillan, chief investment officer for Commonwealth Financial Network. When asked about his biggest economic concerns for the United States in 2017, he cited executive actions by President-elect Trump, followed by increasing inflation and political dysfunction in Congress (see Election Is ‘Start of the Show, Not the End’: Commonwealth’s McMillan).

Gary Shilling, founder and president of A. Gary Shilling & Co., cited the rise of populism as the top geopolitical concern for 2017, followed by increased incidences of terrorism. He agrees that executive actions from Trump are the top economic concern for the U.S. in 2017, and adds a potential equity bubble and political dysfunction in Congress as additional concerns.

Sam Stovall also cites the rise of populism as the top geopolitical concern, and worries Congressional dysfunction will be the biggest issue impacting the economy in 2017. He also worries about executive actions by Trump and a potential equity bubble. Stovall was chief equity strategist for S&P Capital IQ until it was acquired in October 2016 by CFRA Research, where he is chief investment strategist.

Mark Balasa, co-founder and CIO of Balasa Dinverno Foltz, who reports monthly on the consensus of fellow advisor members of The Alpha Group, believes the rise of populism is the greatest geopolitical factor investors and markets are facing. He cites an equity bubble as the most significant economic worry, followed by the potential for more interest rate increases from the Fed.

Economic Outlook: Dow at 20,000+

McMillan predicts the Dow Jones Industrial Average will reach 21,000 by the end of 2017, up slightly from 19,756 on Dec. 9. He predicts similar mild increases for the S&P 500 and Nasdaq Composite indexes: 2,400 and 5,700, up from 2,259 and 5,444, respectively.

McMillan believes the financials, energy and industrials sectors will perform best in 2017, while health care and utilities will struggle.

Stovall was less bullish about the energy sector. He believes the coal and consumable fuels sectors will have the worst performance in 2017, along with construction materials, metals and mining, and security and alarm services. His picks for sectors that will outperform include biotechnology, food retail, footwear, health care distributors and real estate services.

He predicts the DJIA will close at 20,550 on Dec. 31, 2017, and the S&P 500 will close at 2,335.

Balasa is more optimistic. He estimates the DJIA will reach 22,100; the S&P 500 will reach 2,530 and the Nasdaq Composite will close at 6,175. He also has high hopes for the financials sector, which he predicts will show the greatest appreciation in 2017.

Shilling has a more negative outlook. He believes the major indexes will decline in 2017, predicting the DJIA will close the year at 16,000, the S&P 500 at 1,900 and the Nasdaq Composite at 4,300. He believes infrastructure and the military will benefit the most in 2017, while multinational companies will suffer.

Our panelists predict an average 2.47% growth rate in GDP. Balasa was the most bullish on GDP in 2017, predicting 2.9%, compared to Shilling’s 2%.

The Fed: More Rate Hikes

This issue was going to press as the Federal Reserve held its final FOMC meeting for 2016. Minutes from the November FOMC meeting indicated that Fed officials were leaning toward a rate hike in December, Bloomberg reported. Fed Chair Janet Yellen said in November that she plans to remain in her position until her tenure ends in January 2018.

If the FOMC does raise rates in December, and if the economy continues to grow at its current rate, McMillan believes we’ll see two or three more rate hikes in 2017. He expects the federal funds rate at the end of 2017 will be 1.7%, up from its current range of between 0.25% and 0.50%. He puts the 10-year Treasury yield at 3% and inflation at 2%.

(The Fed did raise rates at the FOMC meeting on Dec. 14; Fed Surprises Financial Markets, Indicating 3 Rate Hikes Next Year, and hinted it may make three additional hikes during 2017.-Ed.)

Shilling believes the Fed will raise rates to 1% by the end of 2017, and predicts 10-year yields will reach 1.2% with an inflation rate of 1%.

Stovall also expects two or three rate hikes in 2017, and puts the final funds rate at the end of the year at 1.13%. He predicts 10-year Treasuries will yield 2.45%, and that inflation will reach 2.4%.

Balasa has a similar outlook; he predicts that even with two or three more hikes, the federal funds rate will only reach 1% by the end of 2017, with 10-year Treasuries yielding 2.7% and inflation at 2.5%.

Investing: Indexing Triumphant

Our panelists agree that investors’ interest in index investing isn’t going to go away. A December report from Broadridge’s Fund Distribution Intelligence found that while assets currently managed by RIAs are primarily invested in actively managed mutual funds over ETFs (70% in mutual funds versus 30% in ETFs), net new cash flows are overwhelmingly being invested in passive assets: 80% compared with 20% in active assets.

McMillan believes index investing will continue to interest investors, and predicts index investment products of all stripes will attract the most assets in 2017. He suggests growth-oriented investors consider allocating 58% of their portfolio to stocks, with 38% to bonds and the remainder in cash.

Shilling agrees that index products will continue to attract a greater share of assets, but suggests a much more conservative portfolio, reflecting his concern that the indexes will finish 2017 down year over year. He recommends a portfolio of 40% cash for growth-oriented investors, with the remainder split between stocks and bonds.

Shilling recommended in his November Insights report that investors maintain “extremely high holdings of cash in portfolios.”

He told ThinkAdvisor.com’s Bernice Napach in November (see Shilling Sounds the Alarm: Investors, Load Up on Cash) that market prices don’t make sense in a “topsy-turvy world” of low global growth, weak central banks and political uncertainty.

Balasa cites index products as the most attractive investments to investors in 2017, and suggested a stock-heavy portfolio for growth-oriented investors: 70%, with 29% in bonds and 1% in cash.

Stovall, however, believes mutual funds will attract the most assets in 2017. He shares Balasa’s notion that growth-oriented investors should stay in stocks, suggesting a 65% allocation, with 25% invested in bonds and 10% in cash.

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See ThinkAdvisor's complete coverage of the economy and markets on our Outlook 2017 landing page.

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