2017 Market Outlook

A. Kip Pazol, Chief Equity Strategist January 2017

2016 In Review
The year 2016 began with a state of uncertainty and continued volatility as the S&P 500 and Crude Oil
Prices declined 11.44% and 29.67%, respectively. The Brexit vote temporarily shocked financial markets
mid-year, and following a surprising election result, Donald Trump was elected the 45th President of the
United States. However, over the course of the year, the markets recovered and achieved all-time highs.

In review, for 2016 the S&P 500 ended the year up 11.96%, with earnings in Q3 growing for the first
time since Q1 2015. Price to Earnings multiples and dividend increases allowed for a rewarding year in
equities. The increase in interest rates post-election caused declines in bond prices. However, the
Barclays Aggregate Bond Index did end the year positive with a 2.65% total return.

Below we will address some of the key reasons why we believe the economy may be set up for
accelerated growth.

Our Outlook for 2017 and the Reasons for Optimism

Consumer Confidence Bodes Well for Expanding Economy

Figure 1 - The above chart depicts the Consumer Confidence Index over the last 10 years. The 2008 recession is highlighted in
grey and the post-election result is highlighted in orange.
The December reading for the Consumer Confidence Index was 113.7, according to the Conference
Board. This is the highest reading since August 2001, and is up from a revised 109.4 in November.
Further, the Board stated that the surge in optimism was most pronounced in older consumers.

Consumer spending makes up 68.1% of GDP. Therefore, increased consumer and business confidence,
along with prospects for better jobs (leading to higher wages), is one of the main factors driving our
upbeat outlook for 2017.

Earnings Growth to Ease Valuation Concerns

S&P 500 constituent earnings are set to grow for the second consecutive quarter and end 2016 on a
positive note. These will be the first consecutive quarters of earnings growth in over 18 months, with the
last being Q4 2014 to Q1 2015. This is a major positive development for stocks that have been rising
into the wind and can do a lot, combined with the earnings increase from potential corporate tax cuts, to
ease investors concerns.
The current FactSet estimate for the S&P 500 in Q4 is for earnings to grow 3.0%, this after the Q3
coming in at a surprisingly strong 3.1%. The forward 12-month P/E ratio for the S&P 500 is 17.15,
based on the Jan 3rd, 2017 closing price of $2268.90 and the FactSet forward 12-month EPS estimate of
$132.33. This is higher than the long-term average, but is not too concerning given the backdrop of low
rates and accelerating growth.

Lowering Corporate Taxes

It is pretty easy to quantify the increase in company value from tax cuts. However, the only variable once
the tax cut is implemented is the length of time the tax cut remains unchanged. For instance, if President
Trump and the U.S. Congress ultimately agree on cutting the top corporate rate by 10% forever, that
would increase the value of a given company by 15.3%, all other things being equal. Since the tax cut
goes straight to the bottom line and thereby a companys cash flow, a 10% tax cut from current 35% rate
would result in more than a 15% increase in net income and cash flow. In other words, the effect on
company value is actually more than the tax cut! This leverage effect is due to the tax cut being calculated
off gross as opposed to net income. This would thus lower P/E multiples by the same 15.3%. The
increased cash could be used in several ways:

1) Increase dividends
2) Buy back shares
3) Invest in expansion or productive assets (land, labor or capital)
4) Pay down debt
5) Acquire other businesses or conserve cash waiting for acquisition opportunities

We would expect to see all of the above occurring with the excess earnings. In particular, we expect
an increase in corporate investment due to the cost cutting and underinvestment seen in recent years. It
should be noted that lower tax rates also improve the margins on capital investment projects, making
formerly uneconomical projects profitable.

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Repatriation of Overseas Profit
Currently, U.S. companies hold more than two trillion dollars overseas that could potentially be
repatriated. Such an event would likely bring back into the U.S. economy hundreds of billions of dollars.
Once repatriated, companies will draw on the cash for any number of the uses detailed in the previous
section. Again, those are increased distributions (through either dividends or share repurchases), business
expansion, debt reduction, or acquiring other businesses. What remains to be seen, however, is what
percentage of this cash will be used for expansion, hiring, etc.

For companies with large cash balances overseas (i.e.Apple) there would be the additional benefit of
increasing company valuation. Much like with lower corporate tax rates, a lower repatriation tax rate will
increase company valuations by more than the proposed difference.

Lower Regulatory Costs

Estimates on the amount of GDP that is cut off by increased regulation ranges from approximately .5% to
well over 1% a year, with the Mercatus Center estimating this drag at .8%. In a typical 2.5 to 3.5% GDP
growth economy, any easing will definitely be seen in the numbers.

Manufacturing
Excess cash generated by lowered taxes may also benefit domestic manufacturing. The following factors
will drive the manufacturers who find it profitable to expand their operations in the U.S.:

1) Lower regulatory costsreducing regulation can add .5% to 1% to GDP growth rates, according
to estimates.
2) Cheap natural gas is a comparative advantage for us as a nationdepending on raw material cost
versus labor percentage costs of production, many companies will find it more profitable to
manufacture goods domestically.
3) Geographic Location of end-user demandshipping costs can be reduced if demand is in the
U.S.

Ultimately, it is a mathematical calculation for a company to determine the most efficient place to
manufacture and distribute their products. Keep in mind that as the percentage of materials manufactured
abroad increases, so does the cost of distribution to end users, and the more beneficial it becomes to
transition manufacturing to the United States.

Fixed Income Outlook

Interest rates began to rise rather quickly following the election of Donald Trump. The prospective
acceleration of economic growth and inflation is not positive for intermediate and longer term bonds.
Therefore, keeping maturities shorter is preferred as we expect interest rates to rise across the yield curve
over the next 12-18 months. We prefer corporate bonds over treasury bonds as improving credit in an
expanding economy can be counted on to ease corporate credit concerns (resulting in spread tightening
versus treasuries). Consequently, this can offset the effect of rising interest rates to some degree.
Although there is a concern of inflation, we do not believe we will have severe inflation.

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Risks to Our Outlook
There is inherent risk and uncertainty in every economic outlook, both systemic risk that is unpredictable
and affects the market as a whole and unsystematic risk that affects specific companies or industries. Risk
can be mitigated through hedging, proper diversification, and appropriate asset allocation.

The risks we will be watchingor the knowable unknowns at this pointare as follows:

1) President Trump His unpredictable off the cuff tweeting already affected biotechnology
stocks as he denounced high drug prices. Previously he has spoken of big import tariffs, which
would have the effect of making it uneconomical to manufacture in other countries and import
here.
2) Interest rates In an expanding economy of 2.5% to 3.5% GDP growth for 6 quarters or so,
systematically increasing interest rates would be needed. However, if bond investors, which
influence intermediate and long-term rates, begin to believe inflation is going to increase, it
could lead to rates rising too fast. This would in turn hurt stock valuations. If the Fed implements
regular interest rate increases to normalize interest rates, this should give bond investors comfort
that the Fed is on top of any inflation issues.
3) Dollar strengthening This is very much related to both rate increases as well as the anticipated
GDP growth. If the rest of the world stays in a quantitative easing mode due to slow growth, the
dollar will be strengthening relative to those currencies. A slow modest strengthening is not
much of a concern. But similar to interest rate increases, its the risk of a large rapid appreciation
that would hurt our exports. We dont believe this is a likely event as other countriesGermany
for instanceare showing signs of life and a healthy American economy will only help the
continuation of that trend.
4) China Chinas economy has been, and remains to be, a major point of uncertainty on the global
economy. Due to their governments lack of transparency, it is difficult to predict the probability
of major crises, but they have some issues that they have been slowly trying to address.
Specifically, a credit bubble and a corresponding real estate bubble. Again, slow declines in
those assets and unwinding of misallocations are not a concern. It is the risk of a market driven
shock or fast, substantial drop that would hurt worldwide economies. Emerging markets would
bear the brunt of the pain, but the US markets/economy wouldnt be immune.

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Closing Thoughts
If President Trump and the Congress act on pro-growth policy goals, it is our belief that the U.S. economy
could see a cycle of business investment, which will cause increased hiring at higher-than-average pay,
leading to a growth in consumer spending, which will in turn allow for more business investment. This all
equates to economic growth. Barring the risks previously mentioned (or others that appear), GDP growth
could be at 3%, with S&P 500 Index ending 2017 up in the high single digits, possibly exceeding 10%.
We believe the Barclays Aggregate Bond Index will end the year up 2 - 2.5%. Corporate and high yield
bond should fare better at 3% and 5%, respectively.

About JT STRATFORD
JT Stratford is an SEC-Registered Investment Advisory firm that provides investment management and
employee benefits to individuals, corporations, and institutions throughout the Southeast. Since its
founding in 1995, the firm has established a reputation of complete trust based on a deep knowledge base
and a disciplined approach to investing.
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Note: Opinions expressed are subject to change without notice and are not intended as investment advice or a
solicitation for the purchase or sale of any security. Market conditions, whether it is in a correction, under pressure
or confirmed rally can change quickly which would modify our opinion of the current market condition.

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