A Mid-Year Review Of My 50 2017 Predictions

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by: Ploutos
Summary

In an effort to frame my views for the coming year, I offered a reprisal of a format that covers 50 predictions for global markets.

Predictions for U.S. stocks, international stocks, bonds, and the economy pointed to modest gains for domestic assets and more positive returns abroad.

My predictions have certainly panned out better in global markets and fixed income than they have in domestic markets.

In a year of tech-led gains in the U.S., my skepticism of the megacaps hurt my factor tilts and select picks and pans.

At the beginning of the year, I authored an article laying out 50 predictions for 2017. The picks ranged from highly speculative to coin tosses that I believed had a better than average chance of going in my direction based on market strategies that have historically outperformed. Below, I list the 50 predictions in bold with commentary on how this forecast has fared year to date. I have given myself letter ratings on each prediction. Feel free to assign your own grades in the comments section.

The sum of these predictions signaled below trend gains for U.S. stocks and outperformance by international stocks. In fixed income, these predictions signaled that credit would outperform rates, but that returns would not be as weak as many feared given a muted rise in interest rates.

My picks on global stocks have certainly outpaced my weak picks in the United States as domestic markets have surprised to the upside. The tech-driven rally has led to underperformance of some of my select factor tilts, and misreads on these market leaders battered some of my selections. Generally, my picks in fixed income were strong. It has been an eventful six months, and I will look to update these picks once again at the end of the year.

U.S. Stocks

1. After strong gains in the back half of 2016, gains in 2017 for the S&P 500 (NYSEARCA:SPY) disappoint market bulls, returning just 6%.

While the Trump reflation has cooled, the S&P 500 has produced a strong 9%+ return through the first half of 2017. Market gains are not evenly distributed and have showed pronounced seasonality, so maybe my prediction for the full year will not miss by as far as would be currently projected.

Grade C+

2. The equal-weighted S&P 500 (NYSEARCA:RSP) outperforms its capitalization-weighted alternative.

While I have shown that equal-weighting has generated long-run outperformance versus traditional capitalization weighting, that trend has not held through the first half of 2017. The S&P 500 Equal Weighted Index has produced a total return of just over 8%, lagging the S&P 500.

Grade C-

3. The S&P Small-Cap 600 (NYSEARCA:IJR) outperforms the S&P 500 as domestic-focused small caps outpace large caps once again.

Small caps, which soared on the prospects of a benefit for domestic-focused stocks from an "America First" set of policies, have lagged as the Administration has struggled to pass its legislative agenda. Megacaps, led by the tech giants, have soared. The S&P 600 Small Cap Index (+2.8%) has materially lagged the S&P 500.

Grade D

4. Low volatility stocks (NYSEARCA:SPLV) beat high beta stocks (NYSEARCA:SPHB) as the economic expansion priced into financial markets underwhelms.

Low volatility stocks (+9%) have outperformed high beta stocks (+2%) as market hopes for re-accelerating growth have not materialized. This would have been a bit of a controversial call after high beta stocks soared after the Trump election.

Grade A

5. The combination of Low Volatility and Value (NYSEARCA:RPV) continues its consistent pattern of outperformance.

Low Volatility managed modest outperformance, but Value has lagged. Together, these two factor tilts from the S&P 500 had beat the broader gauge in 15 of the last 17 years, but thus far, 2017 has proven an exception.

Grade D+

6. Similarly, the combination of the Dividend Aristocrats (NYSEARCA:NOBL) and The S&P 500 Equal Weight Index (RSP) continues its equally consistent pattern of market-beating performance.

The Dividend Aristocrats and Equal Weight S&P 500 have both generated more than 7% returns, but lag the S&P 500 at the halfway point. Like Low Volatility/Value, the combination has beat the market for the 15 of the past 17 years but is trailing thus far this year.

Grade C-

7. Efficiency gains spur healthy cash flow generation for domestic producers, and the Energy Index (NYSEARCA:XLE) outperforms the S&P 500 despite only marginally higher oil and gas prices.

Efficiency gains have made domestic production more competitive, but this increased supply has led to a global glut that has lowered prices despite OPEC cuts. Energy has produced weak year-to-date returns (-14.7%).

Grade D

8. After a 25% drop in 2016, the SPDR Pharmaceuticals Index (NYSEARCA:XPH) rebounds to outperform the S&P 500 as pressure on drug pricing recedes.

This pharma ETF has produced a total return of 10.4% through the first half of 2017, just marginally outperforming the S&P 500. While the fervor over drug pricing has calmed, uncertainty around healthcare remains.

Grade B+

9. REITs (NYSEARCA:RWR) modestly outperform the S&P 500, including reinvested dividends as the fear of higher rates that plagued the sector in the second half of 2016 largely fail to materialize in the New Year.

Rates have headed lower, but this particular index has lagged, producing a total return just slightly positive. While falling rates have been a benefit, concerns over brick-and-mortar retail have weighed on some of the top holdings in this fund. Mortgage REITs (REM), on the other hand, have produced total returns of 13%.

Grade C

10. After strongly outperforming in 2016, the Materials sector (NYSEARCA:XLB) lags the broader market.

I picked the wrong commodity. Oil has tanked, but the broader materials sector has modestly outperformed. The representative ETF produced returns just above the S&P 500 in the first half.

Grade D+

11. Equal-weight technology (NYSEARCA:RYT) meaningfully outperforms the top-heavy capitalization-weighted technology index (NYSEARCA:XLK), a sector fund that is 15x more popular with investors than the alternative weighting scheme.

The equal-weight technology ETF produced a 14% total return in the first half, slightly besting the cap-weighted technology ETF, which returned 13%. This certainly wasn't meaningful outperformance, but I was nonetheless surprised that equal-weight tech bested the cap-weighted tech, given the strong gains from the market leaders.

Grade B

12. Facebook (NASDAQ:FB) falls as the number of unique visitors drops, and advertisers begin to question the efficacy of the platform in turning page views into consumer activity.

I have never been a Facebook believer, and as the company has gained to become the fifth most valuable company in the world, I look more wrong every day. While I have never given Facebook a dollar, markets have faith that advertisers will continue to do so. For the 12 months ending, Facebook's $30B in revenue was 1.5x the $20B produced by advertising giant WPP plc (WPPGY). Facebook, up nearly 30% in 2017, is valued at $436B, and WPP plc is valued at $26B.

Grade D

13. Amazon (NASDAQ:AMZN) earnings grow by 25%, but equity gains are in the single digits as the company's stratospheric equity multiple contracts modestly.

First quarter operating income was actually down slightly from 1Q16, but the stock soared nearly 30% in the first half. Price-to-trailing 12 months earnings stand at 182x.

Grade D

14. Friendly overtures by SoftBank (OTCPK:SFTBF) to the Trump Administration, which included the onshoring of thousands of jobs, leads to the support of a merger between Sprint (NYSE:S) and T-Mobile US (NASDAQ:TMUS).

While Sprint and T-Mobile have continued their flirtations, recent news has seen Comcast (CMCSA) and Charter (CHTR) considering a joint bid. Sprint is down slightly on the year but up over 80% year over year.

Grade C

15. Spurned in the cable media derby for Time Warner Cable by anti-trust concerns, Comcast re-enters the content fray via a large-scale acquisition.

See above. Comcast's content acquisitions have been small bolt-ons relative to its tremendous size and scale. The larger news is the aforementioned potential for a Comcast/Charter/Sprint tie-up.

Grade C+

16. Domestic steel companies which experienced tremendous gains in 2016 fail to outpace the broader market and experience volatility more than 2x the S&P 500 as overcapacity plagues the industry and infrastructure spending disappoints.

Through the first half, domestic steel stocks managed a very meager gain on average (see SLX). Volatility for that representative index was nearly 4x as high as the subdued S&P 500.

Grade A

17. Philip Morris International (NYSE:PM) and Altria (NYSE:MO) combine, reversing a 2008 separation of the faster growing international business as the litigation risk environment is viewed as improved in the United States.

Early in the year, British American Tobacco (BATS.LN) (NYSEMKT:BTI) agreed to a $49B takeover of U.S. rival Reynolds American (RAI). A transformative mega-merger happened, but I picked the wrong one.

Grade B

18. The cost of financing advantage of regulated utilities sees multiple large U.S. utilities acquire gas midstream businesses in a bid to revive stagnant growth and to offset the potential for equity price headwinds from higher domestic interest rates.

Utilities have outperformed the market in 2017 while pipelines have, on average, produced negative total returns given the drawdown in commodity prices. While diverging valuations may prompt more M&A, little has been seen in 2017 so far.

Grade C-

19. Johnson & Johnson (NYSE:JNJ) makes a leveraging acquisition that sacrifices its unique AAA rating.

Johnson & Johnson agreed to acquire Swiss biotech company Actelion (OTCPK:ALIOF) in a $30B all-cash deal in January. Even prior to this transaction, debt has doubled to $32B since 2012, while EBITDA has only increased by a quarter. Ratings remain stable, but the possibility that JNJ seeks to finance an outsized portion of this price tag in a favorable market for corporate debt could squeeze its rarefied ratings.

Grade B

20. Continuing its long history of levering low volatility investments, Berkshire Hathaway (BRK.A, BRK.B) makes an acquisition above $10B in both the utility and consumer non-cyclical industries.

For my mid-year review, I missed my prediction on the utility piece of this by under a week as Berkshire recently announced an $18B acquisition of Oncor. Kraft Heinz's (NASDAQ:KHC), which is more than one quarter owned by Berkshire, sought a $143B acquisition of consumer products company Unilever (UNA.NA) (NYSE:UL) that was eventually rebuffed.

Grade A-

21. Driven by the difference in valuations, Ford (NYSE:F) outperforms Tesla (NASDAQ:TSLA).

While Tesla has shed more than $10B of market cap over the past couple of weeks, it still is up more than 40% on the year. Ford, has fallen by 7%. Tesla is worth about $6B more than Ford. In the first half, Tesla is going to deliver around 48,000 vehicles. In the first half, Ford sold 1.24M vehicles in the United States, which is about 48,000 per week. You might think that Tesla's higher valuation is driven by its higher margins, but the company has never produced an annual profit. Ford produced $7B of net income last year and is trading at just 7x forward earnings. Despite all these numbers, Tesla has been the stock to own in the first half. Its valuation is predicated on the company ushering in a transformative era for electric cars. I remain skeptical, but the market can remain ebullient far longer than skeptics can remain short.

Grade D-

22. Apple (NASDAQ:AAPL) retains its spot as the most valuable company in the world, but Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG) closes the gap.

In the first half, Apple's 25% total return outpaced Google's 15%. Its lead as the world's most valuable company grew.

Grade C-

23. An activist investor takes a large stake in battered health and wellness store operator, GNC (NYSE:GNC), which more than doubles the annual return of the S&P 500.

This was admittedly an "out there" pick. I posited that a company that has produced steady free cash flow in its niche specialty retail market would find a way to cut debt and reposition amidst a careening market plunge in 2016. The stock is down another 28% thus far in 2017 as the outlook for brick-and-mortar retail remains bleak. While the debt markets have seen a positive tone, retail and energy have been the exception, and this overlevered retailer is seeing resistance from its lenders in extending its maturity profile.

Grade D-

International Stocks

24. Emerging market stocks (NYSEARCA:VWO) outpace the S&P 500 as the combination of an economic growth rebound, weak EM currencies, and low valuations all prove to be tailwinds after years of underperformance.

Emerging market stocks have posted strong gains in the first half of the year, with the exchange-traded fund referenced in my prediction returning 15.03%, solidly outperforming the S&P 500.

Grade A

25. Low volatility emerging market stocks (NYSEARCA:EEMV) generate 2017 returns in the high teens.

This low volatility emerging market ETF has produced a 14.15% return through the first half of the year.

Grade A

26. Buoyed by its weakened currency, Mexican stocks (NYSEARCA:EWW) outperform their brethren north of the border.

Perhaps an unpopular call given the presumption of a weakening relationship with its largest trading partner, Mexican assets have surged in 2017 with the referenced ETF returning 24.03% in the first half of 2017.

Grade A+

27. After lagging in 2016, European stocks (NYSEARCA:VGK) outperform their domestic counterparts.

That has certainly been the case in 2017 as the referenced ETF has produced a 17.28% total return, strongly outpacing the S&P 500.

Grade A

28. The European Dividend Aristocrats generate low double-digit returns.

A composite of the 40 highest dividend yielding Eurozone companies within the S&P Europe BMI Index that have maintained or increased their dividends for 10 straight years returned 9.52% in Euro terms and 17.87% in USD.

Grade A

29. Similarly, low volatility developed market equities (NYSEARCA:EFAV) produce low double-digit returns and outpace their U.S. counterparts.

With mid-year returns already at 15.37% for this representative ETF, I risk the prospect of underestimating their gains. This equity sub-asset class has certainly produced strong first-half returns.

Grade A

Bonds

30. The 10-year Treasury yield briefly eclipses 3% mid-year but ends 2017 at 2.65% as another year passes without the prospect of meaningfully higher long interest rates materializing.

The yield on the 10-year Treasury zoomed from 1.37% on July 5th, 2016, to a peak of 2.62% on March 13th. After oscillating throughout the first half of the year, the 10-year rallied 14bp to 2.31% at the June month-end close. Certainly, higher long interest rates have not materialized, and my muted tone for the prospects of a rate sell-off proved even too aggressive.

Grade B-

31. The yield curve ends 2017 flatter as the market reprices its optimistic expectations for economic growth.

The 2010s spread has narrowed from 125bp at year-end 2016 to just 92bp at the end of the first half of 2017. Fed-induced rate increases in the front end have been met by more skepticism about long-term inflationary pressures in the long-end.

Grade A

32. Corporate credit spreads, backed by improving economic growth and corporate profitability, tighten modestly. The leading high-yield corporate bond exchange-traded funds (NYSEARCA:HYG) and (NYSEARCA:JNK) produce a 6% total return.

Credit spreads have tightened across investment grade, high yield, emerging markets, and securitized credit thus far in 2017. The two high-yield ETFs referenced generated 4.3-4.6% first half returns, including reinvested dividends.

Grade A-

33. Given the relatively high prices on BB and single-B rated bonds, the gains in high-yield bonds are driven by the most speculative CCC-rated securities as realized corporate defaults recede from the level of the prior year.

Through the first half of 2017, CCCs have outperformed the broader high-yield market, producing a 6.59% total return. Realized defaults, driven by the rebound in commodity prices from the nadir of early 2016, have fallen in 2017, paving the way for the lowest rated bonds to outperform.

Grade A

34. Financial sector corporate bond spreads outperform industrials.

While financials have lagged in equity markets due in large part to the rally in rates, investment grade financial sector corporate bond spreads have generated a 1.63% excess return, besting industrials (+1.51%) and utilities (+1.00%).

Grade A

35. Non-agency residential mortgage-backed securities, a driver of the previous financial crisis, make a meaningful return to the primary market in less complex form, boosting available home credit.

We have seen a pickup in prime jumbo issuance, including a recent securitization of AIG-sourced residential mortgages. In addition to non-conforming jumbo mortgages to prime borrowers above the GSE limits, we have seen an increase in securitizations of re-performing loans. While subprime auto loans have been topical in 2017, there still is very little activity in non-prime residential mortgage securitizations.

Grade A-

Economics

36. The Fed hiked rates twice, increasing the Fed Funds rate in June and December by 25bp.

The Fed has already hiked twice in 2017, but I mis-stated the timing. The Fed Funds rate was boosted by 25bp in both March and June. The futures market is pricing in roughly a 54% chance of another hike before year-end.

Grade B

37. Pressured by a higher U.S. dollar, domestic manufacturing employment falls slightly, countering hopes of a manufacturing renaissance in the United States.

Manufacturing jobs have risen by 55k in 2017 to roughly 12.4 million. While the U.S. has added roughly 1 million manufacturing jobs since the trough in February 2010, gains have slowed in recent months, including a very minor contraction in May. While manufacturing jobs have grown ever so slightly, it has certainly not been the massive onshoring some anticipated in the wake of Trump's win.

Grade C+

38. In a counter to Trump's stated policy, import growth outpaces export growth - largely a function of the strong dollar.

Through the most recent U.S. Census Bureau data from April, imports have risen by 8.3% while exports have risen by 5.0%.

Grade A

39. The unemployment rate falls to 4.7%, and the labor force participation rate moves marginally higher (to 63%), reversing a decade of declines.

The rate of unemployment ticked down to 4.67% through March. Labor force participation was flat on the year through May at 62.7%.

Grade B+

40. Commercial real estate prices rise 4%.

The Moody's Commercial Property Price index was higher by 1.4% through the first half of the year.

Grade B

Other

41. U.S. home prices eke out 3% gains, but high valuations and modestly higher mortgage rates lead to a small contraction in home prices in major coastal metros.

The Case-Shiller index is up around 2% this year. Gains have moderated on the coasts but have still remained positive.

Grade B+

42. Oil prices stay range bound between the high $40s and high $50s as increased U.S. supply is encouraged through a constructive regulatory environment and OPEC members fudge on the pace of agreed to production cuts. The strong dollar also proves a headwind to sustainably higher prices.

Prices have remained range-bound on strong domestic production. West Texas Intermediate has ranged between $42 and $54. This pick was a lot closer to the market than a belief that XLE would outperform from my earlier picks.

Grade B+

43. Gold remains range bound between $1,050 and $1,250.

Gold has bounced from its lows of $1,158/ounce in early January to its peak of $1,294/ounce in early June. Gold has certainly been range-bound and ended the first half at $1,242 but has traded higher than the top-end of my estimated range.

Grade B

44. Two leveraged buyouts of at least $10B are completed in the United States.

Staples (SPLS) agreed to sell itself to Sycamore Partners in a transaction valued at just shy of $7B. Despite favorable financing markets, leveraged buyouts have not been near as common as in the pre-crisis era. Debt-financed mergers have been more the modus operandi for big business.

Grade C+

45. Debate over the future Fed Chairperson and Vice Chairman prompts some minor market volatility. Ultimately, both roles are filled by individuals not currently on the Board of Governors.

This idea will come more to the forefront in the back-half of the year. I have seen ex-Goldman COO Gary Cohn and former Fed member Kevin Warsh mentioned as candidates.

Grade C+

46. A notable cyberattack on our nation's infrastructure leads to a minor risk flare in financial markets and Congressional investigations.

WannaCry and Petya have roiled businesses with ransomware, but the impact on U.S. infrastructure and financial markets has been mute. Recent news of a Russian hack of U.S. nuclear facilities could certainly cause the risk flare and Congressional investigations I predicted, but we are in the early days of this story.

Grade B+

47. A late-night tweet from President Trump on trade prompts a 1% drop in U.S. equity markets the next day.

There have been a ton of late-night tweets, but resultant volatility has been low. I cannot think of a specific example where a Trump tweet directly and negatively impacted markets.

Grade B

48. Overall, the VIX averages 19 in 2017, a pickup in volatility from 2016 when the VIX averaged 16 but still near historical averages.

The VIX has averaged 11.5 as volatility has remained remarkably subdued. The gauge has only even reached 16 briefly.

Grade D

49. There is no progress on a wall on the southern U.S. border.

Nope.

Grade A

50. Driven by record valuations, a National Football League team offers a minority stake in the franchise to public investors to monetize value in front of emerging viewership concerns.

This has not occurred, but it will be fascinating to see if the era of ever-rising TV contracts is coming to an end for the sports juggernaut.

Grade D

Disclosure: I am/we are long SPY, EEMV, EFAV, IJR, NOBL, RPV, RSP, SPLV, VGK, VWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.