This year will be a year of transition for the global economy and global markets, moving from concerns about “relentless stagnation in economic growth” to rising confidence among consumers and businesses, says Bob Doll, chief equity strategist at Nuveen.
It’s not “necessarily animal spirits,” but “we have turned the corner,” Doll explained at his annual New York City event announcing his top 10 predictions for the year.
Indeed, the S&P 500 index ended 2016 with a 9.5% gain while the Dow Jones industrial average finished the year 13.4% higher. Doll had predicted a high single-digit gain in the S&P 500 this time last year – one of 8.5 correct predictions he says he made then (he missed when his most favored stock sectors underperformed his least favorite and when non-U.S. stocks did not outperform U.S. stocks).
(Related: Bob Doll’s 10 Predictions for 2016.)
Unlike most market strategists, however, Doll correctly predicted that Republicans would sweep the White House and Congress during the November election.
In his 10 Predictions for 2017, Doll says he feels like he’s going further out on a limb than normal because the global economy is shifting toward stronger growth, higher inflation and rising interest rates at a time of increasing uncertainty including possible significant changes in U.S. tax, trade, immigration and regulatory policies under the Donald Trump presidency.
“The 35-year disinflationary, falling interest rate world is ending, and that brings some challenges,” writes Doll. Among them, are a stronger dollar, which, along with rising rates, may offset the positives of an improving economy and tax reform that could help boost corporate earnings. “In their environment, investors may be in for a difficult ride,” writes Doll.
Here are his top 10 predictions for 2017:
1. U.S. and global economic growth improve modestly as the dollar strengthens and reaches parity with the euro.
Doll forecasts “mediocre” U.S. growth of around 2%, adjusted for inflation.
On the positive side is the U.S. election has “unleashed a significant increase in consumer and business confidence,” writes Doll. But potentially offsetting that optimism are the aging business cycle, rising interest rates, stronger dollar and continued low productivity growth.
The U.S. dollar is currently worth 1.05 euros.
2. The U.S. unemployment rate falls below 4.4% to its lowest level in 17 years as wages rise at the fastest pace since the Great Recession.
Doll predicts that average job growth will top 150,000 in 2017. In 2016, it averaged 185,000. He also predicts that average hourly earnings growth could exceed the 3.1% level it hit in June 2009, and he’s watching to see if the participation rate, which has been sluggish, rises as well.
3. Treasury yields move higher for the third consecutive year, which would be a first in 36 years, as the Fed raises rates.
The Federal Reserve has indicated it will raise rates three times in 2017, but Doll says that will depend on the strength of the economy and increase in inflation. He says just two Fed rate hikes are possible, and he’s forecasting the federal funds rate at 1.25% by the end of 2017 and 2% by the end of 2018.
Doll predicts the yield on the 10-year Treasury will end the year at 3% this year and 3.5% next year.
Among bonds, Doll favors munis, corporates and sovereigns, in that order, but all are expected to underperform stocks.
4. Stocks reach their 2017 highs in the first half of the year as earnings rise but price/earnings multiples fall.
Doll predicts the S&P 500 will end 2017 at 2,350, about 4% above its current level.
The stock market will be supported by a stronger economy and rising earnings, but rising inflation and rising rates will pressure price/earnings multiples. Support from tax reform and regulatory reform, which could result in repatriation of foreign earnings, could be delayed, says Doll.
Although he expects “pro-growth measures to be passed in 2017,” they’re not likely to take effect until Jan. 1, 2018, writes Doll. He predicts that a “tug of war between rising earnings expectations and eventual valuation (P/E multiple) deterioration will suppress equity prices.”
5. Stocks outperform bonds for the sixth year in a row and for the first time in 20 years while volatility rises for both asset classes.
Stocks will outperform bonds because bond prices will decline as a result of an increase in growth, both real and nominal. The yield on the 10-year Treasury bottomed at 1.37% on July 8. Doll says that cash, rather than bonds, “may be the more interesting diversifier” for investors.
6. Small caps, cyclical sectors and value beat large caps, defense and growth sectors.
Small caps have already begun to beat large-cap stocks due to the rise in the dollar, expected tax changes and slowing global trade, and Doll expects that pattern will continue. In addition, he’s forecasting that stronger growth and current valuations favor cyclical stocks over defensive stocks and growth stocks, respectively. He also predicts that dividend-paying stocks will continue to underperform.
7. Financials, health care and tech sectors will outperform energy, utilities and materials.
This has generally been the pattern since the presidential election, and Doll expects that will continue with financials, the market leader since the election, continuing to benefit from prospects of regulatory easing in 2017, as well as cheap valuations. Health care stocks are “a good opportunity beyond headline risks,” and tech stocks should benefit from growth and value characteristics,” writes Doll.
8. Active managers’ performance improves as flows into equities rise.
Doll says the 2017 will be a stock-picker's market, which is why active managers could outperform the broader indexes and benchmarks. “Active equity managers have struggled in recent years, but perhaps the stars are finally aligning for a long-awaited reversal in this trend.”
It’s one that Doll as a senior portfolio manager at Nuveen would welcome.
9. Nationalist and protectionist trends rise as pro-domestic policies are pursued globally.
"The Brexit vote, Trump victory and Italian referendum – which led to the resignation of Italy’s prime minister – are all examples of this trend, which is “worrisome,” according to Doll. “This issue won’t be decided in one calendar year but should be monitored carefully.”
The Netherlands, France and Germany all hold national elections in 2017.
10. Initial optimism about the Trump agenda fades in light of slow legislative progress.
“While we believe fundamental change is on the way, it may not be as easy as it appears,” writes Doll. He explains that comprehensive legislation rarely passes without significant revision and even if legislation passes in 2017 it’s likely won’t take effect until next year. In addition, he notes that “the mood of the markets may sour if Donald Trump’s protectionist rhetoric… resurfaces.”
Given these predictions, Doll suggests that investors maintain an overweight in equities but choose carefully. “Gains will likely be narrower and more focused on specific companies and investment styles so selectivity will be crucial." He favors companies that generate free cash flow and has a preference for small cap stocks in cyclical sectors.
Selectivity will also be important when choosing bonds, according to Doll. In addition, he sees a role for alternative assets such as real assets, real estate including equity long/short or market neutral.
--- Related on ThinkAdvisor:
- Bob Doll Judges His 10 Predictions for 2016
- Bob Doll: ‘Trump Rally’ Hides Market Risks
- Bob Doll: Don’t Worry About China; Worry About Corporate Taxes