Stock market investment risks in 2017 will be greater than that in 2016, but overall stocks should edge higher, a JPMorgan report predicts. Greater uncertainty will reign but market volatility will pretty much trade in a range for the majority of the year, stated the report, titled “2017 Outlook — More Upside but Greater Uncertainty.”
While Trump brings “uncertainty,” he is “mostly pro-growth” and could add to $20 EPS over coming years
The report expressed concern for geopolitical risks and increasing uncertainty regarding the incoming US Presidential administration. Categorizing the Trump administration “mostly pro-growth,” the administration is expected to add up to $20 to S&P 500 earnings per share over multiple years as inflation expectations are rising. On the basis of improving fundamentals JPMorgan expects 7-8% upside potential based on stronger EPS top line performance.
The report pegged a 2400 S&P 500 target with 2% year-over-year GDP growth and inflation, measured by core CPI, coming in at a healthy 2.3% level.
“While the US macroeconomic cycle may get a boost from the proposed (Trump) fiscal stimulus, corporate tax reform and de-regulation, both the passage and efficacy of these measures are far from certain at this moment,” the report said, pointing to main market risks being a stronger US dollar and higher rates.
Higher interest rates could be a significant issue. Goldman Sachs predicted four rate hikes in 2017 while Bank of America Merrill Lynch is looking for nearly that level. The JPMorgan, for its part, noted that, much like the January 2016 stock market sell off, the rate hike could lead to fundamental and systematic investors selling at the same time sending stocks lower.
The rate hikes, particularly if they are significant, could “destabilize equity P/E, Emerging Markets, the housing market, and US equity segments such as multinationals, domestic manufacturing, bond proxies.”
Higher rates correlate with a higher US dollar. Considering that the US appears as the only nation engaging in significant 2017 rate hikes, the dollar is expected to rise significantly relative to major currencies. This “undercut the ability of the new US administration to revive US manufacturing or use the fiscal deficit to re-ignite growth.”
Looking overseas, the report noted the obvious: the wave of populism could put pressure on the European Union and increase immigration tensions, although the later isn’t entirely a market concern more so than a political one.
The Middle East, an increasing powder keg since the Iraq invasion, is likely to see turmoil extend, particularly in Syria. While the report predicted higher oil prices, the relatively low prices, well off the $100 level seen in 2014, is expected continue to exert pressure on regional oil exporters.
Kolanovic’s hand apparent in volatility analysis
In putting together its 2017 market forecast, the report played into the hands of one of its prominent authors, Marko Kolanovic, JPMorgan’s noted derivatives analyst.
With uncertainty as a key driver for 2017, volatility and its related market impact – a topic too which Kolanovic has an almost soothsayer ability to recognize – will be front and center and has been nicknamed Gandalf for that reason.
According to JPMorgan’s macroeconomic model, the CBOE VIX appears to be underpricing risk by nearly ~3 points too cheap (1 standard deviation). “However, we are not convinced that the average VIX level will capture these increased risks and think that the VIX in 2017 will likely trade in a similar range to 2016.”
Protracted periods of low volatility are likely to mask underlying fundamental risks, which will materialize in the form of micro market moves. Expect to see the hedger’s worst nightmare: “quick outbursts of volatility that may not last long enough to be captured by an average investor.” If volatility and stock prices so quickly move higher and lower it is unlikely to impact risk parity strategies to the same degree as if volatility and stock prices moved in a more accommodative fashion.
If volatility and stock prices so quickly move higher and lower it is unlikely to impact risk parity strategies to the same degree as if volatiilty and stock prices moved in a more accomidative fashion.
Another volatility concern is a US recession, which JPMorgan only considers a 28% probability. A downside risk to volatility is that “a quick and effective US fiscal stimulus alongside continued monetary accommodation that causes a rally in risky asset classes.” To benchmark market risks, keep an eye on increases in bond yields and strengthening of US dollar as volatility trigger points.
When looking to understand market risks, don’t limit information sources and analysis to those only in mainstream. “Given the failure of many traditional data sources to anticipate geopolitical developments this year,” investors should look to traditional and non-traditional sources, including “independent media outlets”, commonly mocked by some as “fake news“.
Value stock trend to continue, low volatility stock trend over
In terms of stock sectors, JPMorgan looks to a trend continuation from their 2016 call to rotate out of Momentum factor exposure and into Value. This move highly correlated with high growth as well as low volatility and high quality stocks, but one of these factors might be avoided.
“Looking ahead, a reflationary backdrop in an expansionary phase of the business cycle should remain supportive of further rotation into Value, while continuing to pose risk for Low Vol and Quality stocks,” the report said, coalescing with other analysis and putting it in line with the expansionary phase of the business cycle.
2017 could see record net share repurchases of nearly $500 billion, representing nearly 2.5% of market capitalization.
While we expect stronger top-line growth to drive EBIT margin improvement (operating leverage), especially for Energy and Financials, the current macro backdrop will likely exert some counter pressure resulting in flat net income margin in 2017. We are modeling roughly flat S&P 500 net income margin of 10.3% for next year (vs. consensus at 10.7%).
JPMorgan’s long investment themes include: Corporate Tax Beneficiaries (JPAMCTAX Index); Repatriation Candidates (JPAMREPA Index); Infrastructure Linked Stocks (JPAMINFR Index); Deregulation Beneficiaries (JPAMDREG Index); Reflation Linked Stocks (JPAMREFL Index); Defensive Energy 2017 (JPAMEN17 Index).
On the short side consider Trade Protectionism (JPUSTRDP Index) and Wage Sensitive Stocks (JPAMWAGE Index), while stock sectors to overweight include Energy, Materials, Healthcare and Financial stocks.