december | 2016 navigator dispatch · 2017-01-11 · investment perspectives from mainstay and our...

Navigator DispatchInvestment perspectives from MainStay and our independent boutiques

December | 2016

2017 Investment Outlook “History will be kind to me for I intend to write it.” —WinstonChurchill(1874–1965)

Will the Trump bump continue?

The stock market is ending 2016 on a positive note. And, as shown in Figure 1, profits are starting to recover. With growth having improved in the U.S. economy since mid-year, an uptick in inflation, and less slack in the labor market, the Federal Reserve (Fed) expects to raise rates three times in 2017.

In our view, 2017 should mark a time when monetary policy takes a back seat to fiscal policy. President-Elect Donald Trump’s victory in November, along with a Republican sweep of Congress, opens a pathway for reducing taxes, rolling back regulations, and increasing spending on infrastructure and defense—all tailwinds for the market.

Figure 1: As stock market profits recover in 2016, we see a promising start to 2017

Source: Bloomberg, 12/13/16. Sales and earnings growth (actual and estimated) are represented by the S&P 500 Index, which is widely regarded as the standard for measuring large-cap U.S. stock market performance. An investment cannot be made directly into an index. Past performance is no guarantee of future results.

On the radar screenn Uptick in inflationn Rising interest rates n Volatile, single-digit return environment n Changing financial landscape

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Q4 15-10

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Actual Sales Growth Actual Earnings Growth Estimated Sales Growth Estimated Earnings Growth

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Figure 2: The world economy is expected to grow over 3% in 2017

Less than 0%

0% – 2%

2% – 4%

Over 4%

2017 Gross Domestic Product (GDP) Projections

U.S. GDP: 2.3%

Global GDP: 3.5%

China GDP: 6.4%

Sources: Bloomberg LLP and International Monetary Fund (IMF), December 2016.

Given current valuations, a growing economy, low but rising inflation, and firming commodity prices, the majority of our independent investment teams believe it is reasonable to expect a bumpy, single-digit return environment for stocks. Rising inflation and Fed tightening that might occur at a faster pace than markets currently expect could pose challenges for investment-grade bonds.

As displayed in Figure 2, the December Bloomberg survey of professional forecasters pins real economic growth in the U.S. at 2.3%, 6.4% in China, and 3.5% globally in 2017. One wild card is the degree to which President-Elect Trump is able to reignite growth. If he is successful, his policies could spread. We see more upside than downside risk to growth in the U.S. in 2017, but political uncertainty makes Europe a wild card.

Inflationary pressures are building, and we expect this theme to progress further in 2017, as developed countries' central banks target 2% inflation and wage growth is now at seven-year highs in the world’s largest economy.

A recent agreement by the Organization of the Petroleum Exporting Countries (OPEC) and other oil producers should help improve the supply/demand balance in the energy market, leading to higher prices in the year ahead.

2017 Investment Outlook December | 2016

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Fed tightening The Fed enters 2017 expecting three rate hikes for the year. The market currently expects two.

First deal since 2008 OPEC will reduce its oil output by 1.2 million barrels per day. Non-OPEC producers will cut half as much.

2017 Investment Outlook continued from previous page

There is a broad-based consensus among our fixed-income investment teams to side with opportunities in credit over developed country sovereign debt. Profit growth should assist the former, while Fed policy and the possibility of larger fiscal deficits could have the opposite effect for Treasury securities.

Within equities, our boutiques are focusing on companies with robust opportunity sets for profit growth before them. Profit and cash flow growth is expected to drive returns ahead rather than valuation expansion or contraction.

Our Strategic Asset Allocation and Solutions (SAS) team1 is of a view that the United Kingdom (UK) will have some hard-to-calculate risks associated with the Brexit vote. Additionally, Italy will have a caretaker government until its next election, possibly in 2018. Important elections lie ahead in the Netherlands, France, and Germany. Given the likelihood of rising support for Euro-skeptic parties for 2017, other equity regions look more appealing than Europe. U.S. equities top the list from a growth perspective, while Japan and the emerging markets have appeal from a long-term valuation perspective. The team also believes commodity-sensitive assets have attractive valuations.

Figure 3 highlights several challenges and opportunities corresponding to today's investment environment.


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2017 Investment Outlook continued from previous page

Profits to drive stocks Profit growth, rather than multiple expansion or contraction, is expected to drive equity returns.

Figure 3: Today’s investment environment presents both challenges and opportunities2

Investment Challenge Rationale

Uptick in inflation CommoditiesCommodities are attractively priced by historical standards versus consumer prices. The beneficiaries of relatively cheap and abundant energy in the U.S., including downstream users of hydrocarbons, may also do well, as inflation rises.

Rising rate environment

Floating Rate Floating rates should bode well in a rising rate environment, as their coupon rises in tandem with interest rates.

Short Duration High Yield

Both short duration and high yield securities are less sensitive to rising rates by nature. While past performance is not indicative of future results, the asset class has historically performed well in recent rising rate environments. 3

Volatile, single-digit return environment

Convertible BondsConvertibles provide decent upside market participation while bond-like features provide some protection in down markets. With a wide range of outcomes possible in 2017 given a new administration in the U.S. and political uncertainty in Europe, this hybrid feature of convertibles bonds is attractive.

Liquid AlternativesWe believe liquid alternatives can help diversify a classic stock-bond portfolio given their low correlations. Hedged strategies such as risk arbitrage have lower betas (market sensitivity) than the market at large.

EquitiesEquity strategies that seek out cash flow growth and efficient capital allocation may be better positioned than a singular focus on high dividend yields.

Flexible StrategiesThese strategies can lock onto the most persistent trends in credit and yield curve movements to help manage against potential blind spots.

Changing industry landscape

High Active Share and Passive Investing

Investors have been migrating away from actively managed strategies that closely track their benchmark in favor of more economical forms of passive investing, while focusing on active strategies that are able to differentiate and add value relative to the benchmark, thus demonstrating a high "active share." Active management typically charges higher fees.

1. Provider of asset allocation, economic insights and investment expertise to New York Life and MainStay Marketing/Sales. Support NYLIM Product Development Team in identifying, testing and creating new investment strategies.

2. Source: MainStay Investments, December 2016. Past performance is no guarantee of future results. 3. Sources: Morningstar, MainStay Investments, as of 11/30/2016 using periods from 1998–2000, 2004–2006, 2009–2010, and 2012–2013. In those periods

Short-Duration High Yield performed well, relative to other fixed-income securities.

Investment opportunities and insights Our Investment teams enter 2017 with insights regarding their area of specialty, collectively addressing far-reaching topics spanning the path of interest rates, value along the yield curve, opportunities in credit, global growth conditions, equity market valuations, commodity prices, financial investment products, and more.


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Boutique/Core Capabilities Investment Outlook

n Expect continued economic growth and upward pressure across the yield curve, as the U.S. economy nears full employment, wages rise, and commodity prices strengthen.

n Resurgence in business capital expenditures may be warranted in 2017, given a prolonged lull, an aging capital stock, rising unit labor costs, and higher commodity prices. A possible tax holiday on repatriated cash could also allow firms to redeploy foreign earnings domestically.

n Increased infrastructure and defense spending is likely and can provide a fiscal boost to the economy, while improving the decaying infrastructure in the U.S.

n Market turbulence caused by political tensions in Europe makes other geographic regions appear as more attractive destinations for capital.

Systematic Equity Teamn While value, momentum, and sentiment factors may be unpredictable in the short

run, over long periods of time these tried-and-true investment attributes have demonstrated a remarkable robustness.

n As global growth accelerates, we would expect bottom-up value and sentiment factors to benefit.

n The ability to go long and short in a disciplined manner allows for a higher active share and a more precise toolkit for managing risk.

Fundamental Equity Teamn We continue to seek out firms with sustainable growth. Such firms typically benefit

from strong secular trends, solid business models, competitive advantages, and high barriers to entry.

n Smart cities, demographic s, and new technologies, such as mobile payment systems, are among the secular trends in our purview .

n A high conviction, high active share strategy benefitting from secular trends offers a reprieve from the general uncertainty investors may face in 2017.


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n Crude prices should rise moderately in 2017, as global crude oil supply and demand return to equilibrium, and storage inventories should drop to historically normal levels.

n Exploration and production drilling activities are off their 2016 lows and are expected to increase further by the second half of 2017.

n Increasing U.S. production should bode well for midstream businesses, especially those with excess pipeline capacity.

n Donald Trump’s campaign focus on energy independence, infrastructure projects, and reduced regulation should translate into a favorable environment for mid-stream energy companies.

n Current Master Limited Partnership (MLP) valuations enjoy a discount to historical levels, other energy stocks, and yield-oriented equities.

n With the incoming Trump administration, the U.S. outlook for 2017 will be very different than 2016. Right now, the market is focused on his economic platform, with the key positives being corporate tax reform, deregulation, and infrastructure spending.

n Inflation is likely to increase moderately, which means the Fed is set to hike 2–3 times in 2017 and the U.S. dollar may continue to strengthen.

n Higher rates should prove a headwind for equity valuation multiples.n Improved earnings-per-share (EPS) growth should help dividends increase, and

corporate tax reform and repatriation could lead to a record year for buybacks, providing another tailwind for the shareholder yield approach.

n The U.K. Brexit process and Europe’s busy electoral calendar suggest sluggish growth and weaker currencies for these regions.

n In Asia, a weaker yen ought to help Japanese exporters, while China is likely to continue on its unsustainable, debt-fueled growth trajectory.

n Despite the cyclical upswing, we are still believers in secular stagnation over the medium to long term given the outlook for labor force and productivity growth is largely unchanged.


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n Volatility is likely to rise given equity valuations and political events favoring populist movements.

n Divergent monetary policies and geopolitical risks will introduce additional uncertainty for currency-sensitive investors.

n Investors will continue to shift assets back into commodities, as global growth firms up and broadens.

n Fee sensitivity will likely accelerate growth in exchange-traded fund (ETF) assets under management.

n Smart beta bond exposure may gain continued investor acceptance as a low-cost, but dynamic solution in a low-yield environment.

Global Fixed Income Teamn Expect President-Elect Donald Trump to implement his economic agenda calling

for lower taxes for households and businesses as well as an increase in fiscal spending—especially on infrastructure.

n In the near term, both policies should stimulate the U.S. economy, leading to an increase in confidence, jobs, and discretionary income.

n The yield curve may continue to steepen in anticipation of stimulus and higher inflation, but the magnitude will depend on the scope and scale of infrastructure spending and tax cuts.

n Expect the federal government to issue more debt, in order to fund a growing deficit driven by fiscal spending.

n More issuance may result in the continuation of spread compression in the corporate bond markets and upward pressure on interest rates.

n Credit spreads will also likely compress, due to stimulative policies. n Most corporate sectors will fare well in 2017; however, some sectors may be negatively

impacted by President-Elect Trump’s proposals, including hospitals (potential repeal of the Affordable Care Act) and media & telecommunications.

n Our investment positioning is subject to change, as more information is disclosed regarding the President-Elect’s economic plan.


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High Yield Teamn Strength in energy and commodity prices (oil, iron ore, copper, and coal) underpins

the recent performance of high yield. n Historically, high-yield fixed income has performed relatively well during periods of

rising rates, as it often signals improving economic conditions and inflation. n The credit fundamentals of U.S. high yield remain broadly constructive, given the

strength of the U.S. economy and the credit quality of the marketplace. Over 50% of new issuance over the past several years has been BB or better, and the largest issuers are generally publicly traded companies raising capital for corporate mergers and acquisitions and refinancing.4

n By contrast, a decade ago, roughly one-quarter of new issuance was leveraged buy-out financing.

n The U.S. high-yield market continues to represent a sensible, low-duration fixed-income investment option in an environment in which stable, unleveraged income is difficult to obtain.

n As per potential risks, a steep jump in interest rates or a change in commodity momentum could lead to a bout of increased volatility.

n We believe floating rate loans are complementary to investors’ overall fixed-income allocations, and may provide competitive risk-adjusted returns in a rising rate environment.

n At the current level of short-term interest rates, floating rate loans are at parity or above the Intercontinental Exchange London Interbank Offered Rate (LIBOR) floors that are in effect. Any subsequent increases in the Federal Funds Rate will be accretive to yield on floating rate securities.

n Credit defaults are expected to remain below historical averages. High-yield and floating-rate credit fundamentals remain favorable, and economic growth should improve amid anticipated fiscal stimulus.

n The impact from a sell-off in energy markets last year has moderated, as energy prices have recovered from their lows.

4. MacKay Shields LLC, as of December 2016.


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n Global growth accelerates slightly, led by U.S. growth and stabilization in emerging markets.

n U.S. growth accelerates into 2018, driven by fiscal stimulus, especially tax reform.n U.S. interest rates begin a consistent upward path toward nominal GDP. The dollar

remains strong.n Inflation sees modest upward pressure, but commodity inflation fades after an

early resurgence.n With price-to-earnings (P/E) multiples at 17–18x, earnings growth and upward

revisions will drive differentiated stock price performance—advantaging fundamen-tal stock pickers.

n We believe high municipal to Treasury ratios should begin to normalize, as we proceed through 2017.

n Uncertainty with respect to policies of the new administration, the Federal Reserve, and domestic and global economic conditions will likely lead to higher volatility—creating an environment best suited for active management.

n We believe our portfolios are well-positioned for the potential of a flattening yield curve and tighter credit spreads.

New York Life Investments engages the services of federally registered advisors to subadvise the Funds. MacKay Shields LLC is an affiliate of New York Life Investments. Cushing® Asset Management, LP, Epoch Investment Partners, Inc., and Winslow Capital Management, LLC are unaffiliated. Cornerstone Capital Management LLC is an affiliate of Cornerstone Capital Management Holdings LLC, a wholly owned subsidiary of New York Life Investment Management Holdings LLC. Fixed Income Investors is a multi-product fixed-income investment manager and a division of New York Life Investments. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

Not FDIC/NCUA Insured Not a Deposit May Lose Value No Bank Guarantee Not Insured by Any Government Agency

1720189 MS373-16 MS65w-12/16

For more information 800-MAINSTAY (624-6782) mainstayinvestments.com

The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results. All investments are subject to market risk and will fluctuate in value.

Commodities are investments in instruments and companies that are susceptible to fluctuations in certain commodity markets. Any negative changes in commodity markets (that may be due to changes in supply and demand for commodities, market S-4 events, regulatory developments or other factors) could have an adverse impact on those companies.

Floating rate funds are generally considered to have speculative characteristics that involve default risk of principal and interest, collateral impairment, non-diversification, borrower industry concentration, and limited liquidity. The Funds may invest in foreign securities. U.S. dollar-denominated securities of foreign issuers can be subject to different risks than U.S. investments, including less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in U.S. or foreign tax or currency laws and monetary policy.

Alternative investments are speculative, not suitable for all clients, and intended for experienced and sophisticated investors who are willing to bear the high economic risks of the investment.

Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.

High yield securities (junk bonds) have speculative characteristics and present a greater risk of loss than higher quality debt securities. Funds that invest in bonds are subject to interest rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk which is the possibility that the bond issuer may fail to pay interest and principal in a timely manner.

Active share is a method of determining the extent of active management employed by an investment manager and a significant tool for helping investors find those active managers that do outperform their benchmarks. Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Credit spread is the difference in yield between a U.S. Treasury bond and a debt security with the same maturity but of lesser quality. Fed Fund Rate is the rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. Intercontinental Exchange London Interbank Offered Rate (LIBOR) is a benchmark rate that some of the world’s leading banks charge each other for short-term loans. It serves as the first step to calculating interest rates on various loans throughout the world. Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices. Sovereign debt is a central government's debt. It is issued by the national government in a foreign currency in order to finance the issuing country's growth and development. Valuation is the process of determining the current worth of an asset or a company. Yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates.


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december | 2016 navigator dispatch · 2017-01-11 · investment perspectives from mainstay and our...

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