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2017 Outlook Report - What a Difference a Day Makes

January 6, 2017

 

Our base case outlook for 2017 is for the equity market to post a mid- to high-single digits total return driven by low double digit increase in earnings (of around 11% for the S&P 500), offset by a modest multiple contraction (trailing P/E dropping from 26x to 22x), and a 2% dividend yield. We believe the US economy may surprise a bit to the upside, fueled by hope for fiscal stimulus and tax reform, and inflation stabilizing around the Federal Reserve target of 2%. With resulting nominal GDP growth of 4.5% or better, we expect long term rates to continue to climb as investors seek higher risk assets. Offsetting these positives, pugnacious trade policy from the incoming administration, a pugilistic congressional minority, and protracted Brexit negotiations in Europe could put pressure on this somewhat rosy outlook.

 

Review & Outlook

 

What a difference a day makes. As 2016 was strolling through its final stretch, the equity market was on pace for a midsingle digit return, much better than 2015’s less than 1.5% return, but not anywhere close to the double digit returns of most of the post-2008 financial crisis years. But then Tuesday November 8th, 2016 came along, and the market’s playbook was thrown out the window. What was expected to be a Hillary Clinton win that would maintain the status quo of monetary accommodating policy offsetting continued fiscal gridlock with a Republican controlled Congress, was instead replaced with a Donald Trump presidential win and continued Republican majority in Congress which could now unleash fiscal accommodation on an economy which, although growing, had been stuck in the “new normal” of low growth for too long. In the less than two months left in the year, the S&P 500 added 5% to its performance, putting its total return at just under 10% (9.8%) for the year, doubling its performance of the first 10 plus months.

 

 

We had expected 2016 to be a mid-single digits return year for equities and although that proved right for most of the year, the November-December rally proved us wrong. The post-election rally in equities was matched by an equally impressive selloff in Treasury bonds, with the 10 year note yield increasing from 1.88% on Election day to 2.45% at year-end. With the Federal Reserved unchanged in its modest rate increase forecast expectations, the yield curve experienced a rapid steepening with the spread difference between 10 year Treasury notes and 2 year Treasury notes increasing 25% from about 100 bps to 125 bps at year-end.

 

 

The credit markets started the year bearing the weight of the shakeout in the energy space, as the depressed price of oil proved many balance sheets were unsustainable, particularly in the oil and gas exploration and production space. It is estimated that more than $70 billion of energy debt has defaulted since the peak of oil in 2015. In last year’s outlook report, we highlighted a list of energy companies which we believe had such large amounts of secured and total debt to make their viability extremely perilous in a world of $50/barrel or lower oil price. Of these 17 companies, 6 have been able to weather the downturn and have seen their equity values increase materially. Of the remaining 11 that have witnessed a deteriorating equity value, 7 have declared bankruptcy, wiping out equity holders.

 

 

As can be seen by the following chart, the high yield market was able shake off the deluge in the energy space relatively early in the year, and with the lack of contagion to the remaining sectors of the economy, risk appetite started to return to the market. With Moody’s expected speculative grade default rate of 4.5% for this year, we believe risk appetite will continue to drive spreads lower, particularly if fiscal accommodation under the incoming administration materializes. For the full year, we believe the high yield market could post a 10% total return, driven by a current yield of around 6%, and spread tightening of as much as 100 bps. Such an outlook, as compared to our equity market expectations, could make credit risk the most attractive risk adjusted reward for the year.

 

 

Although we generally look for individual securities in the debt and equity markets, for those that take more of a sector approach to investing, we believe the following sectors should outperform if our macro-projections prove correct: financials, energy, industrials, materials, and consumer discretionary, while those that may underperform include telecom, utilities, healthcare, and consumer staples.

 

As always, we thank you for your interest and support, and welcome all questions and suggestions.

 

 

About the Author

Dimitri Triantafyllides, CFA

President

Sixty Guilders Research, LLC

dimitri.triantafyllides@sixtyguilders.com

(704) 968-9074

 

 

Disclosure Statements

 

This report is for your information only and is not an offer to sell or a recommendation to buy the securities or instruments named or described in this report. Additional information is available upon request. The information in this report has been obtained or derived from sources believed by Sixty Guilders Research, LLC (Sixty Guilders) to be reliable, but Sixty Guilders does not represent that this information is accurate or complete. Any opinions or estimates contained in this report are current as of the date of the report and are subject to change without notice. Copyright © 2017 Sixty Guilders Research, LLC.

 

Conflicts of Interest. Sixty Guilders, its employees and its affiliates may from time to time hold securities mentioned in this report, either long or short, whether relying or not on information provided in this report.

 

Sources of Information. The information in this report has been obtained or derived from sources believed by Sixty Guilders to be reliable, but Sixty Guilders does not represent that this information is accurate or complete. Estimates for revenue and cash flow (EBITDA) are derived from street expectations as of the date of publication, therefore changes following the publication of the report are not reflected in the report. Other estimates in the report are provided by Sixty Guilders and may similarly be changed following the publication of the report.

 

Ratings. Sixty Guilders does not provide buy, hold or sell recommendations on the debt and equity securities profiled in its reports. Instead, Sixty Guilders force-ranks securities under coverage on a percentile scale, ranging from 100% (highest possible percentile) to 0% (lowest possible percentile). As a result, Sixty Guilders’s rankings are evenly distributed across the percentile spectrum of 100% to 0%. In its reports, Sixty Guilders discloses rankings for a company’s equity appeal and credit quality in 10 percentile increments rounded to the lowest 10 percentile increment. This format is also followed for a company’s peer group (“industry sector”). Industry sector rankings similarly rank sector fundamentals against the broader Sixty Guilders coverage index. In order to preserve the ranking relevance on our index data, company credit and equity percentile rankings are not rounded when displayed on the index. Furthermore, rankings on company reports are only current as of the publication date of a report, and may change as a company’s credit or equity relative appeal may improve or deteriorate following the publication of a report. Since our index data are updated daily, credit and equity rankings on the index are more current than those published in reports whose publication date may have been several days or weeks prior to the most recent current ratings.

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