by
President, WFII, and Chief Investment Officer
by
Head Global Market Strategist
by
Head of Global Asset Allocation

Weekly market insights from the Global Investment Strategy Team

  • If investors were looking only at 2016's big events– the U.S. elections, Britain's European Union referendum, and China's currency devaluation– they might have missed that nearly all asset classes moved higher.
  • Looking ahead, it's worth remembering that seeing beyond day-to-day events matters for investment performance.

What it may mean for investors

  • We may see more unexpected events in 2017, but we propose four steps that investors can take to better prepare for the coming year, whatever it brings.

Download the report (PDF)

2017 Outlook—Seeing Things Differently

It's not what you look at that matters, it's what you see.

-Henry David Thoreau

2016 was punctuated by several short bursts of volatility and quick reversals. Early in the year, global financial and commodity markets pulled back on worries about four potential Federal Reserve (Fed) rate hikes and China's potential economic weakness. In the end, these concerns failed to materialize, as caution in Washington and Beijing promoted stability. Midyear, the "Brexit" vote shocked global markets, but investors soon realized that any repercussions were likely months, if not years, away. Finally, the U.S. election drama captivated investors to the very end. If investors were looking solely at these events, they would not have seen what was quietly happening in the background—nearly all asset classes were moving higher, some significantly so. A year like 2016 reminds us that seeing beyond the day-to-day volatility matters when it comes to investment performance.

As we head into 2017, we are looking at the continuation of many trends, but we are starting to see things a little differently.

Five shifts that we believe warrant investors' attention.

  1. For starters, we are seeing consumers finally enjoying mutually-reinforcing positives from employment, housing, and rising wages. Job gains and strength in the U.S. housing market have been supporting household spending. Looking ahead, more sustained wage growth should bolster continued modest economic and corporate earnings growth next year.
  2. We also are seeing inflation differently. Throughout this economic recovery, inflation has been subdued and below the historical average. That may be starting to change. We do not yet view inflation as a threat, but it does appear to be trending toward a more historically-average rate. In some ways, a normalizing rate of inflation is a positive—one sign of an improving economy. However, if inflation were to continue to rise through 2017, it could cap equity valuations and generate additional volatility in fixed-income markets.
  3. Higher inflation could change how investors anticipate Fed rate increases in the coming years— a potential negative for U.S. financial markets. Our view is that the Fed will tread cautiously and may allow inflation to run above its target to promote economic growth.
  4. Commodity prices appear to have bottomed in 2016, but we don't see a substantial rebound in 2017. Instead, we expect sideways commodity-price action and less volatility. This is typical for commodities at this point in the cycle—as supply and demand continue to rebalance amid moderate global growth.
  5. Finally, we foresee more tremors along geopolitical fault lines. Globalization is broadening from trade in goods to more diverse trade that includes capital investment in new technologies and businesses. As new industries emerge and manufacturing struggles, widening income inequality could fuel political discontent. Democracies worldwide are straining to maintain standards of living for all, and we expect these frustrations to spark bouts of financial-market volatility.

With these five shifts as a foundation, we advise investors to consider the following as they chart a course for 2017:

Equity valuations may not advance broadly next year; thus, equity gains could be more limited and harder to capture in index-replicating strategies. Selectivity may become more important. We believe that investors will need to be more selective and active within their equity portfolio.

The potential for inflationary surprises and geopolitical stresses leads our tactical guidance toward a more conservative emphasis—a change from the past seven years. In particular, we suggest investing in higher-quality assets to help reduce the impact of volatility.

Though we do not foresee a U.S. recession in 2017, we are monitoring factors, such as household and corporate debt levels, that could contribute to the end of the current economic expansion. We advise investors to begin preparing by keeping a diversified portfolio that eschews taking more risk for higher yield, and rebalances more often.

As the economic cycle matures, qualified financially sophisticated investors also may want to consider increasing allocations to alternative investment strategies within their portfolios, such as hedge funds and private capital funds, which can present attractive opportunities.

We may continue to see unexpected outcomes in 2017. But, investors needn't be caught off guard by them. It is our view that the signs of change often are evident, and it is how we respond to those signs that matters. When making investment choices, we believe that investors should take a broad perspective, considering the complexity of the world and the speed at which change is taking place. We have titled our 2017 Outlook "Seeing Things Differently" because we want to kick off 2017 by encouraging investors to broaden their perspectives.