A new year has arrived, and much change is on the horizon. In this article, I will focus on what I feel are the five most important trends to follow in 2017.
- Tax Reform
President Donald Trump has made it clear that he intends to target tax reform as one of his immediate priorities. Early reports indicate that both personal and corporate tax rates are on the chopping block. Should new legislation be introduced and approved, which at this point appears to be probable, it could prove to be beneficial for the U.S. economy in a variety of ways. The post-election rally in the stock market most likely has a lot to do with the fact that earnings from publicly-traded companies could see a substantial boost from lower tax rates. One estimate showed that earnings per share for companies in the S&P 500 could improve by 7-18%, depending on how deep taxes are sliced at the corporate level. This is an enormous increase that is independent of an already improved earnings growth forecast. While the expectations for tax cuts have been at least partially priced into what are already steep valuations on most U.S. equities, it could still prove to be a further positive catalyst for stocks prices, if approved. If new tax law is not put into place, this would surely act as a disappointment in the eyes of investors.
Although it has not been a long enough period of time to get excited, the relationship between equity prices, bond yields, commodities, and the volatility index has shifted to begin the year. Usually, the volatility index rises when equity prices decline quickly, which has also corresponded with an overall decline in bond yields and a rise in commodity prices. This has been deemed the “fear trade” by some media outlets. However, the volatility index has ticked higher on some days, in conjunction with a general rally in commodity prices, but with equity prices also hovering near all-time highs. One clear winner from this trend should be active management strategies. For many years, the dispersion among equities has been low, meaning stock prices have mostly moved up or down in unison. With volatility being relatively low, combined with high expectations already built into the potential positive changes on the horizon to both regulation and overall economic conditions, any missteps along the way will likely send volatility spiking higher.
- Trade Policy
Not enough emphasis can be placed on how impactful changes to trade policies could prove to be. This is one area where President Trump will have unilateral power to make a significant impact on the global economy. If Trump proves true to his tough campaign trail messages and slaps tariffs on goods and services imported from other countries, specifically Mexico, China, and parts of Europe, it could send a powerful wave of change to the future prospects of countless companies who have capitalized on cheaper labor and lax tax breaks by keeping cash overseas. The same is true, but to the opposite effect, for those companies who stand to benefit from more dollars being contained within the U.S. economy. Again, this will help and hurt many different companies in a huge way, and could benefit active investment managers as equity prices begin to move more independently. Also, the impact on currencies could be severe.
- Federal Reserve Policy
Perhaps the most interesting trend to watch will be how the Federal Reserve responds to an improving economy and continued pressure from a new group of lawmakers. If this is finally the year that the Federal Reserve does push short-term interest rates higher, history will not be on the side of those who want to see higher equity prices. Almost always, when the Federal Reserve embarks on a path toward tighter monetary policy, the eventual result is an economic recession. Also, it is vital to understand that the Federal Reserve only has authority over short-term interest rates. If the Federal Reserve raises these rates, it does not mean that interest rates on the longer end of the maturity scale will rise. In fact, most of the time, this does not occur. What is far more likely to happen is the yield curve will flatten, and eventually invert, which has historically always preceded an economic recession. Also, monetary policy has been far more powerful than fiscal policy throughout history. Should we begin to see a further flattening of the yield curve, it would most likely verify that we are at or near the end of what has been one of the longest economic expansions in our nation’s history.
- Geopolitical Tension
The fragmentation of the global economy could lead to an increase in tension among political powers. Should nations continue down the path of isolation, i.e. Brexit and trade protectionism, it will likely produce winners and losers across the global economy. Typically when this happens, the losing economies face political upheaval and/or an increase in cross-border aggression. Furthermore, increased and more coordinated aggression towards dangerous groups such as ISIS could result in an overall increase in territorial disputes and bring big changes to global leadership. The seeds of increased division seem to have been sewn of late, and the resulting sprouts could be a large ramp-up in spending on military maneuvers, and an overall rise in anxiety that accompanies an increase in violence.