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Advisor Insights

Outlook 2017: All eyes on America

It's all about the United States and its new leader in 2017. What Trump does there could impact our portfolios here.


Date: December 20, 2016

With so many surprises in 2016, investors are surely asking themselves what might happen next. And it’s a good question, especially with so much ongoing market uncertainty.

Much of the focus for 2017 will be on the United States, as there’s still much to learn about Donald Trump and his policies. By how much will taxes be cut, and what regulations are likely to be loosened? Will he renegotiate trade deals? Is inflation coming? How will the Federal Reserve respond? Will the U.S. dollar continue to soar? What sectors and markets will benefit from a Trump presidency?

As desperate as investors are for answers, they’re going to have to wait for the new administration to chart its course. For now, these unknowns create a wider range of potential outcomes, and investors will demand to be paid a premium for incurring that higher risk, says Jurrien Timmer, Director of Global Macro for Fidelity Investments in Boston.

This uncertainty premium could translate into a lower price-to-earnings ratio for equities, he says, and that’s not necessarily bad for markets. A lower PE ratio usually means either lower prices or higher earnings, and it is possible that inflation and economic growth could drive up corporate profits, he says.

Inflation rising

Indeed, markets are already anticipating higher inflation under Trump, as evidenced by the bond market. The yield on the benchmark 10-year note recently hit 2.35 per cent, up from just 1.3 per cent during the summer. That indicates that bond investors want greater returns for putting their cash into U.S. Treasuries.

Although Mr. Trump hasn’t provided financial details for his plans, economists forecast that his proposed tax cuts and stimulus package would cost trillions of dollars. The challenge is that the U.S. economy has already reached full employment – meaning that all available labour is being used in the most efficient way possible – so any growth is going to be inflationary, says Mr. Timmer.

Inflation will also rise because the Republican party mandate is sweeping, covering not just the White House, but also Congress, two-thirds of state legislatures and two-thirds of state governorships.

“This is unprecedented control by one party,” he says.

Stocks still preferred

Determining valuations will remain particularly difficult until more policy pieces fall into place. The Federal Reserve’s recent 0.25 per cent interest rate increase will have an impact on prices, as will increased protectionism, which could neutralize the benefits of government spending.

If inflation reappears in 2017, stocks will offer greater protection than bonds. But bonds still have a place in a diversified portfolio, especially bonds indexed to inflation, such as U.S. Treasury inflation-protected securities (TIPS), says Mr. Timmer.

Companies that can raise their prices, such as industrials, should outperform those that don’t, like utilities. Shares of banks, investment firms and insurance companies, meanwhile, are already rising on expectations of higher interest rates and reduced regulation in the financial sector.

Commodities should also do well in an inflationary environment. Steel and cement, for example, would see increased demand from Mr. Trump’s proposed infrastructure plan.

Uncertain emerging markets

Higher commodity prices usually translate to stronger stock performances in emerging markets, especially those of major commodity exporters such as Brazil and Russia. But Mr. Timmer says it remains too early to forecast how emerging markets are likely to perform in 2017.

Developing-nation performance has lagged since Mr. Trump’s election victory, as investors worry that new protectionist rules will hurt exports from these countries. People are also reacting to the new-found strength of the U.S. dollar, which raises the price of emerging-market government debt.

Still, “If the U.S. economy does well, then emerging markets can benefit,” says Mr. Timmer. “But if there’s a trade recession, they won’t do well.”

Whatever happens, 2016’s surprises did make one thing clear to investors: Market reaction to change is instant, leaving retail investors almost no opportunity to “get in,” he says.

The best strategy in a period of uncertainty? Have a good investment plan and stick with it. If changes are necessary, then take advantage of the market’s gyrations to rebalance, says Mr. Timmer.

“Don’t get emotional and be that person who sells at the bottom,” he says.

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