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2017 Investment Outlook: Cautious Optimism

Christopher Wolfe, CFP® and CFA® Chief Investment Officer, First Republic Private Wealth Management
February 17, 2017

As we usher in 2017, the prevailing political philosophy is shifting as President Donald Trump works to reduce regulations and taxes and increase spending. The new administration must now begin to undertake the hard work of developing legislation to implement policy proposals.

You may get caught up in news and speculation about what comes next, and you may even be convinced to make changes to your investment portfolio. But stay focused: The market’s long-term behavior is not generally determined by the actions of the president or Congress, even if those actions create short-term market responses or swings. Inevitably though, it’s market fundamentals — including corporate earnings and economic health — that will drive long-term performance. For this reason, you may risk losing out by reacting to short-term market dynamics.

Rather than reacting to current events, focus instead on creating an investment plan centered around your life goals and risk tolerance while seeking ongoing opportunities to improve long-term performance.

Looking ahead
Although no one can predict what’s to come in the months ahead, we expect 2017 to favor U.S. markets. What follows is a more in-depth look at our forecast and what opportunities investors may have in front of them.

Cash becomes less attractive, U.S. stocks continue to gain
The strengthening U.S. economy and easing of political uncertainty in 2017 make us favor U.S. equities and credit while remaining relatively neutral on cash. Rising corporate earnings and rebounding profit margins should help propel stocks this year. With corporate cash levels rising, companies will likely continue to pay out healthy dividends, acquire other companies and, in general, invest for growth. We expect the S&P 500 to grow in the mid-single-digit percentage range.

Despite our expectation of an overall growth trajectory, the stock market will likely continue to be reactive to surprising statements or policy decisions from the administration. Case in point: The post-election rally was spurred by energy, banking and construction-related companies expecting to benefit from the Trump administration’s emphasis on deregulation and spending on infrastructure. Consumer staples, technology and real estate stocks, on the other hand, saw little or no rally. We will continue to watch how durable corporate profit margins remain throughout the year.

2017 could be a great year for investors who choose stocks carefully and rebalance their portfolios to trim back on asset positions that have become overweight. Taking advantage of market rotations and fluctuations by making sure their portfolios are well diversified across asset classes and market sectors may also prove to be a winning strategy.

Bond investors keep eyes on the Fed
The Federal Reserve’s quarter-point interest rate hike in December and speculation that it will raise rates by a quarter point two or three more times in 2017 shouldn’t overly concern bond investors. That’s because we don’t expect economic growth and inflation to accelerate this year in such a way as to warrant three rate increases.

That said, as the year progresses (and depending on the new administration’s fiscal policies), the Fed may feel pressure to increase rates more quickly to combat rising inflation. We continue to recommend that investors manage interest rate exposure in their bond portfolio by diversifying their holdings across a wide range of bond issues — including both corporate and municipal — and using a laddering strategy that extends out to 20-year maturities. We also like fixed income in portfolios for the stability and income generation it provides.  

Foreign markets face political uncertainty, U.S. dollar remains strong
Global political and economic challenges, including Britain’s “Brexit,” ambiguity about the future of the Eurozone and slowing growth in China have created a complicated environment for international investing. This dynamic, along with a strong U.S. dollar, has favored U.S. stocks over foreign stocks in recent years, and that is likely to continue through the first part of 2017. Uncertainty about how President Trump will handle trade relations with other countries and regions also puts into question how developed foreign economies will fare in the months and years ahead.

Central banks in Europe have kept rates very low in order to spur growth on the continent, which has stayed sluggish. We expect that they will continue to keep rates low even as rates at home climb and the U.S. dollar strengthens.

Certain emerging markets could offer some better prospects this year. Many are currently looking very inexpensive relative to their historic values, and many Asian emerging markets, including India and Indonesia, have a growing number of young adults and middle-class families and are rapidly modernizing to accommodate their demands.

Navigating your portfolio in the new year
We’re generally optimistic about 2017 and think U.S. stocks will continue to thrive. Still, we’ll be watching to see how aggressively the Fed moves to raise interest rates. Given the new political landscape in the U.S. and abroad and the real potential for significant U.S. federal policy changes, investors may encounter shifting market dynamics. However, it’s worth taking a long-term view and focusing on making investment decisions based on your goals that will benefit you, regardless of the political climate.

All analyses and projections depicted herein are for illustration only, and are not intended to be representations of performance or expected results. The results achieved by individual clients will vary and will depend on a number of factors including prevailing dividend yields, market liquidity, interest rate levels, market volatilities, and the client's expressed return and risk parameters at the time the service is initiated and during the term. Past performance is not a guarantee of future results.

Investors should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. 

Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such.  This document may not be reproduced or circulated without our written authority. 

The strategies mentioned in this article may often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. Investors' tax and legal affairs are their own responsibility and readers should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this document.

© 2017 First Republic Investment Management