The surest call to make for 2017 is that higher growth expectations will be paired with the distinct possibility of negative outcomes, putting a premium on diversification and liquidity management.

Since late summer, markets have begun to price in reflation expectations amid rising prospects for fiscal policy to take the reins from monetary policy. Several major market trends have begun to take root, with bond yields rising, financials firming, cyclicals generally outperforming, the US dollar strengthening, and developed markets equities outperforming emerging markets equities.

Recent events have increased the likelihood of a positive change for economies and markets, particularly in the United States. If earnings growth and corporate fundamentals continue to improve as inflation improves (but remains modest), these trends could have considerably more room to run. An environment of improving economic growth and still historically low bond yields, along with largely absent equity valuation extremes, should be supportive of developed equity market performance in 2017.

Seven years into a US economic expansion, and an incredible equity bull market run, it does seem odd to consider what could go right. But cycles do not die of old age, and the nascent global reflation trade suggests the current one may not yet be over. Thus, in our recently published outlook for major asset classes, we noted the potential for a break in the clouds in 2017, even as the things we have been worried about for some time—high valuations for certain risk assets, record-low interest rates, slow economic growth—have not gone away.

Our 2017 outlook discusses the upside potential for developed markets equities, even as downside risks remain elevated. In emerging markets equities, valuations are still low, particularly on a relative basis, but risks—including a Chinese debt crisis, prospects for continued US dollar strengthening, and the potential for barriers to trade emanating from the United States—keep us watching these markets closely. Given the many current uncertainties on the policy front, an outlook calling for US equities to once again outperform seems most likely. The prospective policy mix of the incoming administration would seem to support corporate profits, but the devil is in the details, which have been sorely lacking, and valuations for US equities remain elevated. At the same time, the outlook for developed markets equities outside the United States in 2017 is less certain despite more supportive valuations and equally or more attractive earnings growth expectations. Balancing these prospective rewards against the risks leaves us recommending roughly neutral allocations within global equities.

Within credits, more niche opportunities seem better positioned than traditional high-yield bonds. Commodity-related assets, which may benefit the most from US President-elect Donald Trump’s policy agenda, have seen many of the potential benefits quickly priced in. Bond markets have seen seismic shifts in recent months. The early July low that may have marked the end of the 35-year bull market in US Treasuries means investors should carefully review deflation-hedging portfolios; duration risk remains tilted to the downside. Currencies have been volatile in 2016 and big moves could continue, with US dollar strength over 2017 the most likely possibility.

As we look across asset classes, we see moderate to expensive valuations, solid but not spectacular fundamentals, and wildcards such as geopolitical shocks. By far the biggest wildcard for the 2017 outlook is the rise of protectionism and an anti-globalization backlash across the developed world.

As 2016 comes to a close, we remain concerned that investors are stuck in a low-return world, where they will struggle to earn 5% in real terms. Accounting for our views across asset classes and considering the number of economic and political wildcards, investors should make sure portfolios are aligned with risk tolerance and return objectives and positioned to persevere in a variety of environments.

—Capital Markets & Investment Strategy Research

Read more on our views in Outlook 2017: A Break in the Clouds, published December 8.