Inside:

Economic Outlook 1

Equity Outlook 2

Alternative InvestmentsOutlook 3

Fixed-income Outlook 3

Conclusion 4

ECONOMIC OUTLOOKCitizens across the nation were

shocked at the outcome. The Novembersurprise came out of nowhere.

Yes, the Chicago Cubs did triumph inthe World Series, the first baseball cham-pionship for the Windy City in 108 years.But a bigger November upset occurred afew days later that may have more impacton your wallet.

The surprise election of DonaldTrump as the United States’ 45th Presi-dent has been characterized as a dramaticsea change in economic policy.

Although there are still few specificsabout the future policies of the new ad-ministration, several broad proposals haveraised expectations for a boost to growthin both 2017 and 2018. These includelarge increases in infrastructure, energyand defense spending, significant cuts inindividual and corporate income taxes, re-ductions in regulations, and a repatriationtax break on overseas profits.

There are scant details and significantuncertainty regarding the timing andimplementation of these initiatives, as wellas their financing – and as we all know,financial markets have a tendency to workfaster than Congress. Nevertheless, allindications at this time are for at least amoderate boost to growth in 2017, and astronger pickup in 2018.

Pro-growth fiscal policy at a timewhen the economy is approaching fullemployment could lead to higher priceand wage pressures, and the FederalReserve (Fed) will be monitoring thesedevelopments closely. Following theirdecision to hike the Fed Funds rate by0.25% in December (to a target range of0.50%‒0.75%), we currently anticipatetwo policy rate hikes in 2017. Fed actions

MARKET SUMMARY

� All indications are for a moderate boost to growth in2017 and a stronger pickup in 2018.� Pro-growth fiscal policy at a time when the economy is

approaching full employment could lead to higher priceand wage pressures.� We currently anticipate two Fed policy rate hikes in

2017.� Rising interest rates typically are a drag on stock

returns, but that might not be the case over the firsthalf of the year.� While consumer confidence is high, the valuation levels

for stocks are reaching dangerous levels that could causeproblems if political promises don’t materialize.

� OPEC’s planned cuts in oil production quotascould push global prices higher, providing support forexploration and production in low-cost U.S. oil basins.

Financial Markets, Businesses and ConsumersAdjust to a New Political Landscape

Economic and Financial Market Outlook — January 2017

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UNEMPLOYMENT RATE

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are always conditional on the datareported, so they may be forced toaccelerate their path toward furthermonetary policy tightening if coreinflation and economic growthmeasures strengthen.

While the U.S. economy mayget a boost from domestic fiscalpolicies, it remains vulnerable toglobal risks and headwinds. Thesepotential headwinds include ongo-ing political uncertainty in Europe,a possible slowdown in Chinesegrowth, a stronger dollar (due tohigher U.S. interest rates) and anincrease in global trade protection-ism. Clearly, if these conditionscome about, the economic landscapewould soften considerably.

To this end, central banks acrossthe globe may have reached an in-

flection point. They are approachingthe limits of monetary policy – nowgenerating diminishing benefits andincreasing risks. Policymakers seemto be realizing that strategies such asnegative interest rates may not be aneffective response to structural prob-lems. As such, they have been slowingadditional monetary stimulus andconsidering fiscal adjustments.

In the United States, recenteconomic indicators continue to behealthy. In particular, November’s178,000 increase in payroll employ-ment was almost exactly on top of thethree- and 12-month averages. Theunexpected drop in the unemploy-ment rate, from 4.9% to 4.6%, wassomewhat overstated by a decline inthe labor force, but the three-monthmoving average of hourly earnings

remains at a post-recession high. Soin all, the jobs situation is consistentwith what the Fed regards as steadyimprovement in labor market condi-tions. (Chart 1)

Our growth outlook for de-veloped markets remains modestbut steady, supported by slowlyimproving economic fundamentals.While forecasters have downgradedglobal growth outlooks for the pastfew years, the consensus outlook of3% appears achievable this year. Wealso expect a sustained but fragileenvironment for global trade andmanufacturing given China’s ongo-ing rebalancing and the need forstructural adjustments across emerg-ing market economies.

The U.S, economy has grownat 2.1% per quarter on average sincethe “great recession” ended in 2009.Still, the United States remains thedominant global economy and weexpect it will continue to grow in2017 at an improved rate of 2.5%,despite ongoing global challenges.(Chart 2)

EQUITY OUTLOOKDomestic equity markets have

taken a positive turn since the Presi-dential election. The S&P 500 is up6.0% and the Small Cap index hasincreased 10%. The enthusiasm hasnot spread to International marketsas they are up less than 2%. There isa renewed sense of hope that the en-vironment businesses operate in willimprove with a stronger economy,less regulation, and lower taxes.

For this year, we believe thepositive momentum for equities willcontinue, at least into spring wheninvestors get a little more concreteevidence of what changes will andcan be made. Prospects of a strongereconomy and a small increase ininflation have been unkind to bondinvestors as longer term interest ratesrose sharply and produced the worstmonthly return for bond funds inNovember 2016 that we have seen in12 years.

U.S. REAL GROSS DOMESTIC PRODUCT

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REAL GROSSDOMESTIC PRODUCT

Slight improvement inGDP growth expectedfor 2017 as businesssentiment improves.

n Year-over-Year (YOY)n YOY (Estimate)*— 10-year Trend— Sustainable Growth Trend

CHART 1EMPLOYMENT RATE(March 1994 throughNovember 2016)

Lower labor participationrate helped lower the mostrecent unemployment rate.

n Labor force participationn Unemployment rate

Rising interest rates typicallyare a drag on stock returns, but thatmight not be the case over the firsthalf of the year. Our reasoning isthat over the last 12 months, inves-tors have been pouring money intobond funds at the expense of stockfunds. As returns for bond fundsdiminish, we expect to see moneyreversing and flowing back to stocks,sending prices higher.

There is a lot of optimism afterthe election with consumer confi-dence approaching levels last seen in2007. While investors feel good, thevaluation levels for stocks are reach-ing dangerous levels that could causeproblems later in the year if the hopesand promises don’t materialize. Aswe approach the late spring, we willhave a pretty good idea of what willactually change on the tax, trade,regulation and entitlement front.

Over the past 44 years, LargeCap stocks in Europe, Australia andthe Far East (MSCI EAFE Index)have had an annual return of 9.3%versus a 10.4% return for the S&P500. Over the past several years Eu-rope and Japan have had their shareof political and economic problemsalong with falling currencies versusthe U.S. dollar, but has it been overlydiscounted? Over the past fouryears the cumulative return for theS&P 500 is 71% while the EAFEindex has risen only 18%. Emergingmarkets have fared worse, declining10%.

We have been underweight inInternational equities for most of thepast four years until last summer,when we went back to our long-terminternational recommendation of30% of one’s equity portfolio. Weexpect over the next few years theperformance gap will begin to nar-row.

ALTERNATIVE INVESTMENTSHeading into 2017, we are posi-

tive on the energy Master LimitedPartnership (MLP) sector. The Orga-nization of the Petroleum Exporting

Countries (OPEC) announced aproduction cut that should providesupport for exploration and produc-tion companies to continue addingrigs and increasing capital expen-ditures in low-cost U.S. oil basins.

As production volumes re-cover, MLPs should realize cash flowgrowth with minimal incrementalinvestment as pipeline capacity isutilized. The Trump administrationshould also be more supportive ofMLP performance given the likeli-hood of less oil and gas regulation andan emphasis on U.S. infrastructuredevelopment and economic growth.

There are potential headwindsfor MLPs. One is the end of theeight-year run of low interestrates. While MLPs have not beenadversely affected by rising rates in2016, a steady increase in 2017 couldprove otherwise. Another is thepotential for broad tax reform underthe Republican White House andCongress. While there have been nospecific proposals regarding MLP taxstatus, in the contextofbroad reformsall options could be on the table.

Since the economic and marketrecovery in 2009, hedge funds havegenerally not kept up with equityand fixed income returns, and withtheir higher fee structure, investorshave been reducing their allocations.Public funds have reduced hedge

fund allocations and moved toindexed funds as a way to reducemanagement fees, simplify theirapproach, and appease their publicstakeholders.

FIXED INCOME OUTLOOKThe bond market started 2016

with concerns about slowing globalgrowth and a large drop in energyprices. Treasuries initially benefitedwhile Corporate and High Yieldbonds suffered. The “Brexit” voteto depart the European Unionrattled the markets briefly midyear,but market conditions stabilizedand improving domestic economicconditions helped spread sectorslike Corporates and High Yield.Both recovered from their early yeardeclines.

The latter half of the year waspunctuated with the U.S. electionresults, sending Treasury yields upsharply. After spending most ofthe year below 2.00%, the 10-yearTreasury yield is poised to finish theyear above 2.50%. The recent rise ininterest rates has been eating into thepositive returns of the bond market,with the Barclays Aggregate index up1.94% year-to-date (as of December14), after having been up over 5.00%just two months ago. (Chart 3)

As we enter 2017, the bondmarket expects U.S. Treasury yields

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CHART 3FIXED INCOME SECTORRETURNS YEAR-TO-DATE

Low credit qualitysectors had significantpositive year-to-datereturns.

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esFIXED-INCOME SECTOR RETURNS YEAR-TO-DATE

to rise. Inflation expectations appearto have increased as seen with theelevated breakeven levels for Trea-sury Inflation Protected Securities(TIPS). The prospect of increasedfederal spending and tax cuts inan economy estimated to be nearfull employment has led to a rise ininflation expectations.

The fiscal stimulus expectedfrom the Trump Administration islikely to include a sizable tax pack-age for business and individuals.A reduction in the corporate taxrates would make debt issuanceless attractive in corporate capitalstructures. If this comes to fruition,the bond market would have lowernew supply volumes. Spreads wouldtighten, a positive for bond prices,as supply diminishes and the U.S.Corporate bond market shrinks.

Anticipated interest rate hikesfrom the Fed will place upwardpressure on yields and bond per-formance may struggle. However,

some sectors may be able to eke outpositive returns.

While the average spread forinvestment grade Corporate andHigh Yield are below their historicalaverages, there is still room for ad-ditional spread-tightening. (Chart4) This would be a positive con-tributor to performance. The recentdownward trend in defaults, thanksin part to improving commodityprices, bodes well for lower defaultsin 2017. Moody’s speculative gradedefault rate closed at 4.6% this pastNovember and is projected to easeto 3.2% over the next 12 months.

A strong U.S. dollar will be ahead wind for Emerging Marketdebt. Treasuries will continue tostruggle as yields are anticipatedto rise in the coming months.Municipal bonds may languish asthe market digests the proposedreduction in marginal tax rates forindividuals and corporations. Thissector has already been hit by some

heavy outflows, creating downwardprice pressure and a possible over-reaction to the potential changescoming from the Trump Adminis-tration.

We plan to maintain exposureto the non-government sectors,while steadily improving qualityand liquidity to the portfolios. Port-folio durations are moderately shortto their corresponding benchmarksin anticipation of higher inflationand Treasury yields. Rising yieldsshould help set up the bond marketfor higher returns down the road.

CONCLUSIONWe can expect a Trump ad-

ministration to push a pro-businessgrowth agenda for the U.S. economy.As part of this transformation, wecould also anticipate a Fed shift frommonetary stimulus (interest rates,money supply) to fiscal stimulus (taxreform, government spending) tospark the economic engine.

The Fed finally seems to havefound more resolve in raising inter-est rates, indicating two for 2017.Upward pressure on wages willcontinue in a nearly fully employedU.S. labor market, which in turnmay push inflation up. Lookingabroad, the strength of the U.S. dol-lar could make international trademore challenging.

But as we approach the latespring we will have a pretty goodidea of what will actually change onthe tax, trade, regulation and entitle-ment issues.

commercebank.com/brokerage

COMMERCE TRUSTINVESTMENTCONTACTS

Christie Cody, CFA(816) 234-2415

Mike Cody, CFA(314) 746-8551

Scott Colbert, CFA(314) 746-8557

Cynthia Rapponotti,CFA, CAIA(314) 746-8794

Joe Williams, CFA(816) 234-2564

CTC1216-IM1377B

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DISCLOSURES: The Market Outlook is a special report designed to provide investment information on economic markets for Com-merce Brokerage clients. It is intended to provide general information only and is reflective of the opinions of The Commerce TrustCompany’s senior investment management committee.

The Commerce Trust Company is a division of Commerce Bank. Commerce Brokerage Services, Inc., member FINRA and SIPC, andan SEC registered investment advisor, is a subsidiary of Commerce Bank.

This material is not a recommendation of any particular security, is not based on any particular financial situation or needs, and isnot intended to replace the advice of a qualified attorney, tax advisor, or investment professional. Diversification does not guaran-tee a profit or protect against all risk. Past performance is no guarantee of future results, and the opinions and other informationin Market Outlook are as of Dec. 16, 2016.

Commerce does not provide tax advice or legal advice to customers. Consult a tax specialist regarding tax implications related toany product and specific financial situations.

CHART 4CORPORATE CREDITSPREAD(January 1997 throughNovember 2016)

All fixed-income sectorsare generating a positivereturn year-to-date.

n High Yield(Average 583 bps)

n Investment GradeCorporate(Average 161 bps)

Not FDIC Insured

May Lose Value

No Bank Guarantee

CORPORATE CREDIT SPREADS

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Investment Policy CommitteeDec. 16, 2016