Five Surprises That Wouldn’t Surprise Us in 2017
January 09, 2017
The past year was full of surprises; 2017 may be the same. While we expect modest returns across asset classes, interspersed with volatility, we see five potential developments outside of the consensus view that are distinctly possible.
Surprise #1: The Dow Achieves 20,000…Multiple Times
We went on record several years ago saying the Dow would reach 20,000 much sooner than many thought possible. The index is now within 100 points of that milestone and likely to reach it any day. But the Dow could cross through 20,000 repeatedly, both on the way up and the way down. If so, the US stock market will be volatile, with negative year-to-date returns at varying points throughout 2017.
Surprise #2: The Federal Reserve Hikes Rates Many Times
The market currently expects two to three interest rate increases this year; there could be more. The US economy is close to full employment, which can put upward pressure on wages and encourage businesses to invest. Add in the potential for fiscal stimulus, and faster-than-expected economic growth and inflation may be in the offing. In this scenario, Yellen’s Fed may decide to raise rates more than she or the market is currently assuming.
Surprise #3: Slow-Growth Regions Outpace Expectations
If the US economic growth picks up in 2017, the rest of the world is likely to benefit, including Europe and Japan. Investors currently expect only 1.5% GDP growth from both regions this year. But the export sectors in Europe and Japan are relatively strong, and likely to benefit from stronger demand if the US—one of their largest trading partners—grows faster.
If Surprise #3 materializes, it would likely lead to Surprise #4—probably the biggest.
Surprise #4: The US Stock Market Trails Other Regions
The US market has beaten non-US markets (as represented by the MSCI ACWI Ex-US Index) in six of the last eight years; many investors currently assume the US will lead again in 2017. But, investing is all about expectations, and current expectations are high for the US and low for almost everywhere else. Hence, non-US equities are much less expensive than US equities. If low-growth regions of the world benefit from a pickup in US growth, investors would likely rush to buy non-US equities, and non-US stock markets would likely outperform the US.
Surprise #5: Bonds Deliver Positive Returns Despite Rising Rates
US interest rates will very likely rise in 2017, which should be a headwind to bond returns. But intermediate-duration bonds could still provide a positive return. How? The market has already priced in expectations of faster economic growth, inflation, and interest rates; thus, much of the damage to bond prices has already been done. Interest rates would have to rise very sharply from here to lose more value than their income provides. We calculate that yields would have to rise at least 1% for intermediate muni bonds to have negative returns in the next 12 months.
None of these potential surprises are our base case. There are a number of hurdles to their realization. But we think investors should prepare for the possibility that any of them could happen.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.