This time of year is often spent reflecting on the events that shaped the prior year, and looking forward to the year ahead.  Here we’ll take a quick look back at 2016 and outline our thoughts on what we may see in 2017. 

2016 may go down as the year of political surprise as we saw a surprise Trump victory in the US presidential election and Great Britain voted to leave the European Union.  Each of these unexpected votes was discussed in excruciating detail throughout the year yet had the power to move markets.  We are optimistic in our economic outlook for 2017 as we don't see a recession on the near-term horizon; however, we expect the year to bring its own share of twists and turns.  The unknown unknowns as they've been called make forecasting economic and market returns an imperfect science, but also highlights the importance of having an active strategy in place.  We believe an investment strategy that gives flexibility to adjust portfolio allocation amidst changes in ever-evolving economic and market environments is critical. At TLWM we are constantly looking at a wide variety of economic and market data in an effort to best position your portfolio for the market conditions, and determine whether it’s better to be fully invested or to be more defensively allocated.

We are likely to see a repetition of themes from 2016 while political change in the US and Europe may present us with a new set of challenges.  We believe the following commentary discusses many of the significant elements that could impact the economy, stocks, and fixed income markets for 2017.

• We don't believe a recession is imminent, and feel that economic growth in the US may accelerate.
• The corporate earnings recession ended in the 3rd quarter of 2016 and we feel earnings growth may be more robust in 2017.
• Rate hikes are likely.  The Federal Reserve is poised to raise rates 2-3 times, but will likely be data dependent and we should focus on the pace and path of hikes.
• We will be talking about political changes as president-elect Trump takes office and focuses on making his mark early in the year.
• Political change may present challenges to Europe's economy as a number of elections are poised to test the strength of the European Union.
• Our economic dashboard continues to give us reason for optimism as the fundamental economic data remains resilient.

Political Change:

As president-elect Trump begins his first term in January, we believe politics will continue to be in focus in 2017. Going into the November election there was concern over the potential market reaction to a Trump victory.  Thus far, reaction in stocks has been positive with the S&P 500 rallying almost 6% in the month and a half following the election (through Dec 16th).  We believe that there are a few potential reasons for this reaction.  First, the uncertainty that comes with an election is now behind us allowing investors to focus on fundamental economic data and the outlook for the future.  The other element is more political in nature.  Trump's post election rhetoric has generally been seen as supportive to US economic growth.  While we see this as a positive, a Trump presidency brings with it uncertainty.  We wouldn't be surprised to see market volatility driven by politics this year as potential policy changes or lack thereof could surprise markets. 

Political risk isn't limited to the US as Europe has a number of votes throughout 2017 which could serve to shape the future direction of the European Union.  These include, but are not limited to elections in France, Germany, and potentially early-elections in Italy.  Combine this with the ongoing Brexit negotiations and 2017 is likely to be a pivotal year in understanding what the EU will look like moving forward.  As always, we will keep a close eye on the domestic and foreign political landscape and make tweaks to the portfolio as needed.

The US:

Positioning portfolios during times of political uncertainty can be a challenge as political risk comes and goes.  Looking at the fundamental economic backdrop will hopefully give us a clearer picture of the year to come.  As we look at US economic data we are encouraged, and don't see a recession on the near term horizon.  Our economic dashboard is once again showing few reasons for concern as we see stabilization or improvement in a number of elements including: sentiment (both investor and business sentiment), Leading Economic Indicators, manufacturing activity, and a steepening yield curve.  The only element of our dashboard that gives us reason for some concern is equity valuations meaning that the US stock market may appear expensive.  While valuations can give us a good guidance as to the general value (or lack thereof) in the stock market it's generally not a good short term market indicator.  In addition, the current low interest rate environment (US 10 year Treasury yielding between 2-3%) potentially justifies a higher valuation as alternative investment options may not look as attractive when compared to stocks.  Given this backdrop and recent pickup in GDP we feel US economic growth could be in the 2.5-3% range in 2017.  While this would not be a rate to get overly excited about we are cautiously optimistic that economic growth will continue and potentially accelerate in 2017.

The corporate earnings recession appeared to come to an end during Q3, 2016 as we saw positive earnings growth for the first time in a few years.  Earnings growth appears poised to continue with projections of 11.5% earnings growth for the S&P 500 in 2017, according to Factset.  This double digit earnings growth has been priced in for a few months and there is potential for greater growth depending on the impact of potential policy changes such as corporate tax cuts, deregulation and repatriation.  Tax cuts however, don't guarantee an increase in earnings.  Just as with repatriation of corporate dollars from overseas the decision of how to use extra cash is unique for each business.  We could see a range of spending including infrastructure, M&A, and of course return of capital to shareholders through dividends and buybacks.  The amount allocated to each of these areas could determine the impact of policy changes.

As we weigh these facts we feel there is potential for US stocks to move higher in 2017 and wouldn't be surprised to see high single digit returns for stocks given a steadily improving economic environment and potentially supportive legislative backdrop.

Rates:

We've seen bond yields move rapidly after the US election, with the US 10 Year Treasury recently yielding 2.60% (in December).  This level is higher than the pre-election yield and well off the lows of 1.38% in July (post-Brexit vote). We believe that this move in interest rates can be explained with the increased expectation of growth and inflation within the US economy.  This view is one that has been echoed by the Federal Reserve over the last month or two as they hiked rates for the first time in a year, and set expectations for 2-3 rate hikes in 2017.  It's our belief that the Fed will continue to be data dependent as they look to gradually raise rates and that the path and pace of rate hikes should be watched closely.  While any surprise changes from the Fed will warrant close analysis we don't feel that the current rising interest rate environment poses a huge threat to the US economy (over the next 6-12 months).

International Economy:

As we look outside of the US we are encouraged at the potential for growth as a number of key economic indicators have shown improvement and the IMF recently upgraded their outlook of projected global growth at 3.4% in 2017.  This optimism is certainly cautious as there are a number of potential headwinds to be wary of including political change in Europe, threats to global trade given increased protectionist rhetoric, and currency volatility. 

From a portfolio perspective we believe an allocation to foreign stocks is justified given the economic backdrop combined with attractive stock market valuations as compared to the US.

Risk Factors:

While we have reason for optimism moving into 2017 there are no shortage of potential risk factors to keep a close eye on.  Here we will outline a number of factors to watch closely:

• Political Risk - we've spent a lot of time discussing the political environment and many of the upcoming changes may be expected, but surprises could result in market volatility.
• Currency Fluctuation - The strength of the US dollar will again be in focus as it has the potential to impact corporate earnings, emerging markets, and returns from foreign investments.
• Oil - some of the projected gain in the S&P 500 earnings in 2017 is attributed to the energy sector.  We believe that the oil markets appear to be stabilizing, but any surprises in supply or demand (particularly artificial changes) could impact markets in the US and globally.
• Protectionism- Trump's rhetoric regarding trade and growing protectionist policies around the world could impact global growth.
• Central Banks – while current central bank policies appear in line with expectations any changes in policy may cause markets to react.

So what does this mean for your portfolio?

We believe the risk of recession is relatively low and as such want to be fully invested in our equity portfolios.While we see some additional political risks internationally, compelling valuations in developed and emerging foreign markets lead us to maintain both US and international exposure as we expect to see moderate returns for stocks.We feel a growing US economy and a rising interest rate environment are likely in 2017 and our sector weighting is guided by this.We favor sectors that are boosted by or have little impact from rising interest rates (tech, health care, financials), benefit from accelerated global growth (materials, industrials, and energy), while being cautious on those sectors that may feel headwinds from higher rates (staples, telecommunications, and utilities).

For investors with blended portfolios (bonds and stocks) the increase in bond yields can be frustrating as yield hikes may cause bond values to drop.  As such, it may feel like the bonds are holding the portfolio back.  It’s important to remember that fixed income can play a critical role in the portfolio and might be a key part of an appropriate asset allocation.  When the wind is at our back (stocks are hitting all time highs) it may feel like fixed income is holding us back; however, when stormy weather hits (a stock market correction, or bear market) we might be happy to have a diversified portfolio with assets outside of stocks.  We feel that it is critical to try to build portfolios that seek to survive many different weather conditions.

As we look to the future, one other potential benefit to higher interest rates is the opportunity to add bonds with a higher yield where appropriate.  As bonds mature we could seek to reinvest that cash and further extend your bond ladder.  In this scenario, we view higher interest rates as an opportunity. 

As in any year we expect to see the unexpected and remain ready to monitor and tweak our portfolio allocation as needed.

We wish all of you a happy and healthy year ahead.

Securities offered through LPL Financial, memberFINRA/SIPC. Investment advice offered through TLWM, LLC., a registered investment advisor and separate entity from LPL Financial.

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.
* The Standard & Poor’s 500 (S&P 500) is an unmanaged index. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
* Past performance does not guarantee future results. Investing involves risk, including loss of principal.
* You cannot invest directly in an index.
* Consult your financial professional before making any investment decision.
* Stock investing involves risk including loss of principal.

* The price-earnings ratio (P/E Ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.

* This document is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Texas Legacy Wealth Management and its representatives are properly licensed or exempt from licensure.

* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.

* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.

*Credit risk can be a factor in situations where an investment’s performance relies on a borrower’s repayment of borrowed funds. With credit risk, an investor can experience a loss or unfavorable performance if a borrower does not repay the borrowed funds as expected or required. Investment holdings that involve forms of indebtedness (i.e. borrowed funds) are subject to credit risk.

* Typically, the values of fixed-income securities change inversely with prevailing interest rates. Therefore, a fundamental risk of fixed-income securities is interest rate risk, which is the risk that their value will generally decline as prevailing interest rates rise, which may cause your account value to likewise decrease, and vice versa. How specific fixed income securities may react to changes in interest rates will depend on the specific characteristics of each security. Fixed-income securities are also subject to credit risk, prepayment risk, valuation risk, and liquidity risk. Credit risk is the chance that a bond issuer will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of a bond to decline.