Happy New Year! Our hope for you in 2017 is that you and those you love enjoy good health, and have a prosperous and wonderful year.
We feel there are three things you need to hear from us this year. They are: What's going on in the world, How it affects your planning / investments and What we are doing about it.
- What's going on in the world? The election of Donald Trump has changed the view of relationships with World leaders, and the expectations of how the U.S. will react to flare-ups, international trading and diplomacy. We do not know yet if this is good or bad - just “unknown”. We believe the new Trump administration will be put to the test very quickly from all sides both domestic and internationally. His promised aggressive agenda regarding immigration, law and order, health care, tax-cuts, tariffs, regulatory reductions, infrastructure spending, energy development and the roll back of prior executive actions is creating much discomfort among the status quo, along with much hope for improvements. The real test of his domestic agenda will be the fight of the legislators who sound reasonably co-operative, but are very committed to their large contributors and special interests.
- How does this affect your planning and investments? To those with Estates over $5.5 million, promised elimination of the Estate Tax is very welcomed, and potentially freeing in estate protection and distribution planning. The planned corporate tax reduction from 35% to 15% means companies will see a 20% profit improvement with just the strike of the pen. I do not believe Trump will get the rate down to 15%, but is likely to get it down to 20%. The reduction/ rollback of regulatory reforms frees-up tremendous resources, adding to corporate profitability. The infrastructure improvement promised at an estimated $1 trillion could be very good in stimulating the economy, eliminating many from the welfare rolls, and creating the opportunity for wage gains.
- What are we doing about it?
- Equities: The current U.S. market (S&P 500) is selling at about 20 times earnings, which is about 25% above the historical average of 16 times earnings. All else remaining equal, this would be a good time to scale back equities. Things are not equal though. The tax cuts, regulatory reform and projected infrastructure spending, should add substantially to corporate profits. Just the promised tax cut puts the P/E (price-to-earnings) ratio within historical norms. From an equity position, we are staying the course with the following tweaking: Allocating more to our small and mid-cap positions (these are affected less by international trade risks). Additionally, scaling down some of our healthcare position due to the added risks of the sector being a source of attention to costs in this new administration.
- Fixed Income: With rising interest rates, investment grade bonds normally produce sub-standard returns, if any. Since the election, we have all but eliminated our position in high-yield tax-free bonds, and replaced it with high-yield corporate bonds. Municipal bonds experience two unfavorable hits in this new administration; both rising interest rates, and the lowering tax rates makes them undesirable in the near-term. We continue to overweight the credit risk bonds, senior floating bank loans, and high yield corporates, which have historically outperformed in a rising rate environment. With any luck in the future there will also be an elimination of the 3.8% investment tax.
Our 2017 Forecast
- Equity Forecast: We are of the opinion that this equity market can sustain an 18 P/E multiple, it is currently priced with a P/E multiple of 20 times earnings. If corporate profits improve by 15% with the tax cuts, and pared with 6% estimated earnings growth. These improvements could leave us with a P/E multiple of about 16 times earnings. If the markets can sustain an 18 P/E multiple, that gives us an estimated potential 2017 return on equities of 12.5%. Our estimated returns for equities in 2017, without an anomaly, are 8-10%.
- Fixed Income Forecast: It appears that the economy has shown enough improvement that the Federal Reserve is comfortable to gradually raise interest rates. With that in mind, we expect returns on investment grade bonds to be 1-2%. For high yield corporate bonds and senior floating bank loans, our expectations are 4-6 % returns in 2017.