2017 Economic & Capital Market Outlook

Capitalism and democracy work together to power economic growth and sustain our standard of living; capitalism, with all of its faults, is still the best generator of investment and human capital in the world. Years from now, when we look back on 2017, we expect to find that Donald Trump’s presidential election underscored a profound shift in the political ideology of our time, which in turn impacted our democracy, economy, and our capital markets.

We expect Donald Trump will exercise the office of the President of the United States differently than any other U.S. President. Already, based on his direct involvement in issues such as the cost of manufacturing Air Force One with Boeing, the cost of military planes with Lockheed Martin, jobs in Indiana with United Technologies, political bureaucracy and task forces will be secondary to confronting the issues and direct negotiation. While we are admittedly not sure what impact this will have on the financial markets, we expect that there will be periods where investors are surprised with heightened volatility.

We believe the key drivers to economic growth and price movements in financial assets for 2017 will be regulatory and tax reform, fiscal stimulus and a marginal shift in monetary policy toward higher interest rates. The domestic economy still shows imbalances and is supported by an aggressive asset purchase program that has kept interest rates near historic low levels, stifling capital investment and hurting savers. Banks play an important role in our financial system as the primary facilitators of credit. Incentivizing banks to extend credit to small business is critical to sustained economic growth. By lowering the risk for entrepreneurs to start businesses, we will incentivize business growth, create jobs, and broaden the tax base. Ultimately, small business creates jobs. We expect to see a shift in the domestic agenda, where a focus on structural reform will allow for increased bank lending to small business which, in turn, will increase business formation and job creation.

Also, the shape of regulatory and tax reform next year will impact opportunities for investors. There appears to be a consensus around lowering corporate taxes which will have a direct impact on profit margins. In addition, any tax repatriation will help spur investment capital, share repurchase, and dividend distributions for shareholders.

The larger risks to domestic growth are from global forces outside of the United States. These include the growing populism in Europe and the credit bubble in China. While their direct impact on the U.S. economy may not be readily apparent, to the extent that capital flows are impacted, it will effectively stifle risk taking and capital investment.

Investing is about managing risk, not just taking risk. With the Federal Reserve buying bonds in the open market, the central bank is effectively manipulating and distorting the price of risk for investors. Since the economic recovery is still unbalanced, we believe there is a natural ceiling to how high interest rates will move next year. Any movement to lower taxes—both corporate and individual—will push municipal bond yields higher as banks and other investors reduce their holdings. This could create a wonderful buying opportunity for investors.

By some measures, equities appear overvalued heading into the earnings season next month. We are in that camp. We favor domestic stocks over developed and emerging-markets stocks next year. Small-cap stocks will likely outperform large-cap stocks. With higher interest rates and the potential for thoughtful regulatory reform, we favor an overweight to financial, industrial and technology stocks. Additionally, the repatriation of large cash balances will create opportunities for some global companies for capital investment and share repurchases.

At the end of the day, the equity market and the bond market are still being supported by the monetary policies of the Federal Reserve. We do not expect the Federal Reserve will be in a position to exit those policies over the next four years. With a pro-business agenda moving into the White House next year, we are cautiously optimistic for investment in domestic equities.