2017 outlook for stocks if everything goes wrong

Investors that want to cover all the bases when it comes to market risk might want to consider the very worst-case – and best-case – scenarios for stocks in 2017.

Wall Street’s predictions for the new year are out. The “base case” is for a gain of around 5% for the stock market in 2017. But a deeper dive into stock strategists’ 2017 outlook reports unearthed bearish scenarios that envision the U.S. stock market potentially declining between 10% and 30%. There’s also a bullish vision that sees stocks streaking 20% higher in the new year.

Year-end 2017 price targets for the Standard & Poor's 500 stock index from strategists at 15 Wall Street firms see the large-cap stock gauge climbing to 2363, on average. That equates to a 5.5% gain from Friday’s 2016 year-end close of 2239.

This middling mid-single digit call is built on the premise that the economic recovery and corporate profit growth will gain speed, helped by renewed investor optimism after the election of Donald Trump and high expectations for the president elect’s growth-friendly platform. Trump’s call for lower corporate taxes, less regulation of businesses and sizable spending on infrastructure has spurred a positive upturn in investor sentiment.

But the “bear case” – or worst-case scenario – laid out by a handful of strategists suggest the S&P 500 could end 2017 down as much as 10%, which adds up to a “correction.” Or perhaps plunge as much as 30%, which would put it well into bear-market territory, defined as a 20%-plus drop.

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In its “Year Ahead Report,” UBS Wealth Management Americas, highlighted a key lesson from 2016: “Don’t confuse a base case with a done deal. The past year has been ignominious for base-case forecasts. Donald Trump won the U.S. election. The UK voted to leave the EU. And central banks were forced to ease policy more than previously thought necessary.”

Here’s how the "bear" case and "bull" case of Savita Subramanian, equity and quant strategist at Bank of America Merrill Lynch, differ from her "base" case of the S&P 500 finishing 2017 at 2300, or about 3% higher than 2016’s close. Her base case is dependent on policymakers ability to “deliver growth next year.”

But if that doesn’t happen, look out below, warns Subramanian. In her “bear case,” she won’t rule out a drop to 1600 for the S&P 500, which equates to a selloff of nearly 30%, or what she calls a “typical bear market decline.”

If policy makers “cannot deliver a pick-up in growth,” Subramanian wrote, investors could be disappointed. If the economic backdrop gets worse instead of better as forecasters expect, “markets would likely begin to price in an imminent recession,” she warns, adding that stimulus from the Trump administration could push out the next recession by 12 to 18 months.

The stock decline in 2017 could rival the downdraft at the start of 2016, when the S&P 500 fell 10.5%, or be “even more severe,” she warns. In search of potential trouble, Subramanian will be closely monitoring Trump’s comments related to trade, House Republicans’ comments on deficits and spending, as well as the health of credit markets.

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In sharp contrast, Subramanian’s "bull case" is built on the assumption that everything goes right. If that occurs, the S&P 500 can climb another 21% to 2700, she says.

“It would not take much to see a year of broad-based healing with no major shock,” Subramanian, outlining her best-case scenario, wrote. “The most vaunted growth catalyst is the possibility of a significant stimulus package from the Trump administration next year. Instead of trade wars, we may get across-the-board tax cuts, a repatriation (tax) holiday and infrastructure spending. This could be the catalyst for a traditional euphoria-driven end-of-bull-market rally that could generate 20%-plus returns.”

None of the other 14 strategists comes close to Subramanian’s best-case call. But many warn the stock market can go down if reality doesn’t match investors’ high expectations.

The “downside shock” scenario outlined by investment firm Strategas Research Partners is built on an economy that doesn’t rebound, but instead falls into recession, causing corporate profit growth to fall shy of market expectations. This “bear case,” which the firm places 20% odds on, would cause the S&P 500 to retreat to around 1790, or 20% lower than current levels.

Jonathan Glionna, U.S. equity strategy at Barclays, also offers up a “bear case.” The S&P 500 could tumble to 2000 – a 11% drop – if the U.S. dollar strengthens and interest rates climb a lot higher, causing corporate profits to be less robust. Those twin headwinds could cause “investors to reassess risky assets," he wrote in his report. Glionna, though, doesn’t see a recession on the horizon, citing the strong labor market as a sign of U.S. economic vitality.

Brian Belski, chief investment strategist at BMO Capital Markets, sees the S&P 500 rising 5% in his base case for 2017. But he won’t rule out a 15% fall to 1900 if corporate earnings growth stalls and Trump’s fiscal spending plans don’t come to fruition or if people question their feasibility.

The risk is if “the economy and earnings momentum stall,” says Belski.