Our Fearless Forecast: Beware of fear and greed in 2017

It’s January, which means it’s time for our annual Fearless Forecast. A year ago, we were asked where the stock market was headed over the coming year, how many times the Fed might raise interest rates, whether higher rates would be good or bad for the market, whether oil prices would collapse and what the fate of the U.S. dollar would be. We were asked if we were worried about the future of our country if [insert the candidate you didn’t vote for] was elected, and what about the unstable geopolitical climate and seemingly unstoppable terrorism? How could any of this be good for the economy or stock prices?

This negative sentiment was constantly reflected in the news headlines during 2016. Here are a few that stood out:

  • Washington Post (01/11/2016): “China’s slowdown, financial mayhem cast a long shadow across world”
  • Wall Street Journal (4/21/2016): “Stocks and Bonds Today: Expensive, Expensive, Expensive”
  • Barron’s (9/3/2016): “Barron’s Survey: Strategists Say Beware the Bear”

In case you’ve forgotten, 2016 started with a record loss for most markets in the first week of January. By February 11, the S&P 500 was down 11.9% from its December 1, 2015 closing price of 2,079, and the iShares MSCI EAFE Exchange Traded Fund (symbol: EFA), which is a widely followed barometer for non-U.S. stocks, was down 16.1% (Yahoo! Finance). The culprit for the selloff was fear over looming interest-rate hikes by the Fed, slowing growth in China, falling oil prices, slumping corporate earnings and stocks that appeared fully valued at 16 times projected earnings for 2016. And if that wasn’t enough, a contentious presidential election loomed in November. Both the bull market in stocks and bonds and the economic cycle appeared tired and long in the tooth.

As it turned out, China’s growth didn’t implode, the U.S. didn’t fall into a recession and the world didn’t come to an end. In fact, although the market had every reason to decline in 2016, the U.S. stock market posted respectable gains for the year.

Fear and greed

For me, 2016 is a stark reminder that investors should control what they can and worry less about the latest headline on CNBC or doomsday article in the Wall Street Journal. Namely, this should include:

  • Creating a sound long-term plan
  • Diversifying across multiple asset classes
  • Disciplined rebalancing (sell high, buy low)
  • Keeping expenses low
  • Minimizing taxes

Since March 2009, when the S&P 500 hit a decade low of 666, investors have waxed and waned between emotional periods of fear and optimism. This is the most unloved bull market ever, and I find that most are skeptical of what lies ahead. Specifically, they are worried about the economy, interest rates, a new administration, geopolitical risks and stock valuations. My response: What’s new? Investors will undoubtedly be influenced by these risk factors in 2017, and perhaps like in 2016, they will be yanked off course by fear and greed.

Our 2017 outlook

The economic expansion that began in 2009 is alive and well. The pro-growth/pro-business policies (deregulation, lower taxes) presumed under the incoming administration may finally push economic growth above 3%, extending the expansion and boosting corporate profits. These fiscal policies will replace seven years of monetary policy as an economic lever, providing reflation in the process and pushing aside longstanding fears of deflation.

While bonds will remain a key ingredient in a diversified portfolio, their returns will be muted during the final leg of the economic cycle as inflation and interest rates grind higher. Stocks are thought to be fully valued, but they remain the superior alternative for long-term investors seeking growth, especially with interest rates near historical lows. In a departure from recent years, small and mid-cap stocks should continue to outperform large-cap stocks as the economy breaks above the 2% growth ceiling.

Developed international and emerging market stocks offer better return prospects based on their lower valuations and higher dividends, but it’s difficult to know when investors may finally begin to favor non-U.S. investments in earnest. For now, much like bonds, they remain an important diversifier, but we continue to overweight U.S. stocks.

Since the election, investors have shown a clear preference for value over growth, favoring cyclical investments, such as companies in the basic materials, industrial and financial sectors, while showing similar disdain for defensive blue-chip stocks in telecom, consumer staples and utilities. Defensive stocks play an important role in a diversified portfolio, but their prominence will likely be reduced in the years ahead. We believe the themes above will persist over the last leg of the economic cycle and the bull market, both of which began in 2009.

Missing the best days

Looking back on last year, the biggest lesson for individual investors was how hard it can be to successfully “time the market” in the short term, and how easily investors can be thrown off course by the media and negative headlines. There’s no doubt some succumbed to the “buy high, panic low” syndrome last year, losing out on the market gains that followed the election.

In the chart below, we see that over time, the cost of missing a handful of the “up” days significantly reduces investor returns. Miss the five best days and annual returns fall by more than 1%. Miss the 25 best days, and your returns are a whopping 33% lower on an annualized basis. Missing a handful of the best “up” days in the market over time could mean the difference between retiring on time or not retiring at all. As we look forward to a prosperous 2017, we hope investors will keep last year’s lesson top of mind.

missing-the-best-days

About the Author

W. Kirk Taylor, CFP®

W. Kirk Taylor, CFP®

W. Kirk Taylor, CFP® is Chief Investment Officer at 1st Portfolio Wealth Advisors. He has been advising individuals, business owners, and affluent families about complex investment and financial planning topics since 1988. He writes and blogs frequently about timely investment and financial topics and is the former host of The Investment Challenge radio program broadcast in the Washington, D.C. metro area on Business Radio AM 570/1260.