January 2017 Review and Outlook

Domestic equity markets continued to rally in December. Sentiment in the stock markets and the overall economy turned abruptly more positive in November after the surprise Donald Trump victory in the presidential election. Investors anticipate that the president elect will follow through on campaign promises to lower corporate and personal income taxes as well as reduce business regulations. They expect that these changes will accelerate economic growth and lead to higher corporate profits. The S&P 500 gained 1.98% in December. Fixed-income markets continued to experience a sell-off, however, as investors shifted to risk assets and inflation fears resurfaced. The domestic economy seems to be strengthening, fueled by stronger consumer spending and a robust housing market. We expect the financial markets to remain volatile in 2017 due to the uncertainty of President-elect Trump’s domestic and international policy agenda and his legislative priorities. Here is our view on where things are from an economic and financial-market perspective:

Volatility – While equity markets have generally continued to rally and volatility has declined, we expect uncertainty will return. Investor sentiment has been quite favorable; however, the stock market may face headwinds in 2017 as investors begin to focus on a myriad of potential challenges, such as higher interest rates, a stronger dollar, higher inflation, geopolitical risks, elections in France and Germany, and possible U.S. protectionist policies.

Corporate Profits – Earnings growth is expected to improve in 2017, as higher consumer and business confidence leads to increased spending. We expect the improved manufacturing-sector activity of the past several months to continue. Energy companies are benefiting from higher oil prices relative to a year ago, which should result in stronger earnings.

Interest Rates – The Federal Reserve increased short-term interest-rates by 25 basis points at its December meeting. Importantly, the Fed anticipates raising rates three times in 2017, depending on the strength of the economy. Interest rates are expected to remain “low for longer,” however, when compared to longer-term average-interest-rate levels.

Consumer Spending and Confidence – In December, one measure of consumer attitudes, the Index of Consumer Sentiment from the University of Michigan, reached its highest level since January 2004. A strong consumer sector, which represents approximately 70% of U.S. gross domestic product (GDP), continues to lead economic growth.

Central Banks – The Fed and overseas central banks continue to be accommodative by keeping interest rates extremely low by historical standards, furthering the case for equities as an attractive investment for long-term growth.

Economic Growth – The U.S. GDP increased 3.5% in the third quarter, the strongest growth in two years. The Federal Reserve estimates the economy will grow by 1.9% in 2016 and 2.1% in 2017.

Employment – The economy continued to create jobs at a moderate pace. The most recent official unemployment rate of 4.6% was the lowest since August 2007.

Housing – Sales of existing homes reached 5.61 million units in November, the highest monthly activity since February 2007 and a surge at least partially attributable to buyers’ anxiousness about potentially higher mortgage rates in the future. Housing continues to be a bright spot for the domestic economy. Rising prices reflect demand, with current low mortgage rates also contributing to the positive activity in this important sector.

Energy Prices – Oil continues to trade at around $50 per barrel. These prices, low relative to history, should continue to benefit consumer discretionary spending. At the same time, oil prices have nearly doubled in the past 12 months, helping to increase corporate profits in the energy sector.

Manufacturing – The most recent reading of the ISM Manufacturing Index, released January 3rd, was 54.7, up from 53.2 the prior month. This indicator of activity in the manufacturing sector is at its highest level in two years.

Domestic Stock Market – The domestic stock market, as measured by the S&P 500, was up 3.82% in the fourth quarter and 11.96% for the year. Future corporate earnings, and what investors are willing to pay for those earnings, will continue to be the most important drivers of the near-term direction of the stock market.

Equity Sector Performance - In the domestic equity market for the fourth quarter and the year, value stocks outperformed growth stocks, and small-cap stocks outperformed large- and mid-cap stocks. The best-performing equity-market sectors in 2016 were energy, telecommunications, and financials. The worst performers were health-care, real-estate, and consumer staples.

International Stock Markets – Emerging nations’ equity markets (MSCI EM Index) lost 4.16% in the fourth quarter but gained 11.2% for the year. Brazil and Russia were among the strongest-performing countries in this sector in 2016. Stock markets in developed countries struggled in 2016, with the MSCI EAFE Index up just 1.0%.

Fixed Income Markets – The Bloomberg Barclays Capital Aggregate Bond Index was down 2.98% in the fourth quarter but rose 2.65% for the year. The increased yield on 10-year Treasury notes to 2.44% at year-end reflects a belief that higher economic growth is on the horizon for 2017. The year’s best-performing sector was high-yield bonds, which gained 17.13% in 2016. Municipal bonds were almost flat for the year, up just 0.25% as measured by the Barclays Capital Municipal Bond Index.

Economic Outlook – The domestic economy is currently in solid shape, with strong employment and historically low unemployment, a healthy housing market, low interest rates, and consumer spending at a healthy pace. Low investment by corporations in their businesses has been a weak spot for the economy. The lack of consistent momentum in the manufacturing sector is also a concern. The higher U.S. interest rates anticipated in 2017 will lead to an even stronger dollar relative to other currencies, which will not help U.S.- based multinational corporations increase earnings. If President-elect Trump and the Republican Congress follow through on initiatives to reduce corporate and personal income taxes and the regulatory burden, we expect the domestic economy may break out of the stagnant 1.5%-2.5% economic growth of the past several years. A faster-growing economy may lead to higher inflation.

Stock Market Outlook – We are cautious about the near term. The domestic stock market has risen over 9% since the election, and we would not be surprised to see a 5%-10% pullback in the short term as a reaction to the steady upward trajectory of stocks for almost two months. We expect volatility to continue, especially as corporations begin to report their earnings for the fourth quarter and the new president and Congress begin to set priorities and implement their agenda. We are bullish over the longer term: President elect Trump’s agenda is oriented toward generating higher economic growth in the U.S. that should lead to higher corporate earnings (which drive stock prices).

Your portfolio – The volatility of the global equity markets last year, especially during January, June and October, demonstrated the value of having a disciplined approach and investing for the long term. When markets are volatile, it is important to focus on factors under your control, such as your need for income, your expenses, your liquidity needs, and your time horizon. We are watching the market and will adjust your portfolio should conditions warrant.

Please keep in touch – We ask that if anything changes in your personal circumstances that may be relevant to how we have invested your portfolio, please let us know.

Thank you for your business and the trust you place in us.

Sources: Federated Investors, The Wall Street Journal, CNBC.com, U.S. Commerce Department, MainStreet Advisors The information provided is the opinion of the MassMutual Trust Company, FSB (MMTC) as of the date it was written and is subject to change without notice. It is not intended as investment advice. MMTC has relied on sources it deems reliable. MMTC is not responsible for errors or omissions.

The MassMutual Trust Company, FSB is a federal savings bank and is a wholly owned subsidiary of Massachusetts Mutual Life Insurance Company. ©2017 Massachusetts Mutual Life Insurance Company, Springfield, MA 01111-0001 All Rights Reserved.

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