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What Factors Could Keep Stocks Down in 2017?

January 1, 2017

Equity markets in the US have been riding high ever since November’s presidential election, feeling the boost of the “Trump rally”. While stocks had an incredibly volatile year, the second half of 2016 ended with most indices reaching record highs and flirting with even higher levels. While many predict that President-elect Donald Trump’s incoming administration could be a net positive for the US economy, there are a variety of factors that could offset the current rally, and even lead to a much less rosy year in 2017.

2017 market up or down

Despite the positive prospects for the economy and the US dollar, political, and even monetary policy factors in the country could push down equity benchmarks. Trump’s actions have already sparked some fears of increasing international tension with many of the country’s important partners. From his threats against important trade allies such as Mexico and China, to an increasingly complex outlook for US-Russia relations, the political sphere could spill over on stocks. Additionally, while some sectors of the economy could feel a boost from Trump’s proposed policies, trouble within his own party could ground many of his ambitious policies before they even start.

On the Edge of Uncertainty

Even after the recent run of record closes for major equity benchmarks in the US, some analysts are calling for caution when it comes to forecasting similar success in 2017. Despite the strong finish to this year, and the promise of a steadily improving US economy, there are looming risk factors that could prove to be a drag on stocks in the coming year.

One of the biggest drivers for stocks’ surprising rally over the past month and a half has been the prospect of a more business-friendly administration. With noteworthy business leaders appointed to important economic posts, several sectors have been riding high on the idea of a looser regulatory environment, tax reform, and a business-first outlook. Major segments such as banking and energy have all seen shares soar since the election. Other sectors have not been as fortunate, with healthcare the prime example alongside the defense sector which has recently stoked the President-elect’s anger.

Some have listed policy proposals by the Trump administration as signs that stocks and the economy will kick into high gear. From a reworking of the corporate tax system to encourage more job creation domestically, to an ambitious infrastructure spending initiative, Trump has made his major focus the US economy. However, these plans may be derailed by his own party, which traditionally sees expanded fiscal spending as a major problem and consistently pushes for budget discipline.

When Policy Hurts the Economy

Adding to the potential uncertainty is the prospect of Trump’s foreign policy. Outside of some hotly contested nominations—including Exxon CEO Rex Tillerson as Secretary of State—there are major questions regarding the Trump administration’s relations with key trade partners such as Mexico (one of the US’ largest importers) and China (arguably the US’ major trading ally in the world).

Although no necessarily a negative development, rising interest rates could also hurt equity valuations.  As rates and yields on other assets rise, investors are likely to rotate portfolios away from stocks towards bonds and other asset classes.  Furthermore, the higher the dollar goes, the more expensive US stocks become on a relative basis, pushing valuations lower over the medium-term.

Despite the positive effects a trump economy could have on the economy—a stronger US dollar, an expanded budget surplus, improved job creation—there are major risks on the outlook that could directly impact the US economy, and thus bring instability to equities throughout 2017 in spite of recent record highs.