Stock Chart Rising

Image source: Getty Images.

To be perfectly clear, nobody knows where the Dow Jones Industrial Average will be at the end of 2017. Even those who get it right will have made nothing more than a lucky educated guess. Having said that, it can be interesting to use what we know to make predictions. Using historical trends along with analysis of the current political and economic atmosphere, here are my three best predictions of where the Dow will finish in 2017.

Historical performance under a Republican administration

The stock market historically tends to do better when one political party is in control of the White House and both houses of Congress. This makes sense -- after all, when the government is divided, not much gets done.

So, to make our first prediction, let's use the recent election results, which put a Republican president into the White House, and retained a Republican majority in the House and Senate. Historically, with a completely Republican government, the market has risen by an annualized rate of 16.4% per year. Based on where the Dow Jones Industrial Average stands as of this writing, this translates to a level of 22,612 at the end of 2017.

In rising-rate years

Next, since the Federal Reserve is widely expected to raise interest rates in December, and Donald Trump's economic policies are seen as being conducive to a sustained period of rising rates, we'll use that to form our second projection. There's no guarantee that a multiyear period of rising rates will actually happen, but recent economic data and the election results make it highly likely.

Historically, during periods of rising interest rates, the Dow Jones Industrial Average has increased at an annualized rate of 5.9%. This is sharply lower than the average return of 15.2% in years when interest rates were falling. If rates begin to rise in December as expected, and continue to rise throughout 2017, this translates to a year-end Dow Jones Industrial Average of 20,429.

My gut feeling

If you notice, the two predictions above are somewhat contradictory of one another. Both factors predict that the Dow Jones Industrial Average will rise in 2017, but keep in mind that the index's average historical return is about 9.5% per year. So, one prediction is calling for historically strong performance, while another is calling for weak performance.

With the other two predictions in mind, here are a few other factors that I believe will influence the market's performance in 2017:

  • The recent OPEC agreement to cut production could finally stabilize the supply-demand dynamics of the oil market, and will lead to gradually rising energy prices. This could produce a strong year for Dow components Chevron and ExxonMobil.
  • Financial stocks could have an excellent year because of Trump's anti-regulation platform. Four Dow components (American Express, JPMorgan Chase, Visa, and Goldman Sachs) could greatly benefit from that, as could insurers such as The Travelers and UnitedHealth.
  • On the other hand, I see the real estate sector being a laggard as interest rates rise. Since there are no REITs in the Dow, it shouldn't be affected. This would be a positive factor for the Dow's performance as opposed to that of the S&P 500.

This isn't an exhaustive list, but the point is that Trump's economic policies and the potential rise in oil prices should help more Dow components than rising interest rates will hurt. Because of this, I'll predict that the Dow will gain about 12% in 2017 and will finish at approximately 21,500. Again, this is just my prediction, but I think the Dow will outperform its historical average in 2017 -- just not by as much as it typically does under a Republican government.

Why all three predictions are probably going to be wrong

While these predictions are based on educated guesses, chances are that I'll be completely wrong on all three. Why? Simply put, there are way too many variables that determine the stock market's performance for anyone to make an accurate prediction of how the market will do tomorrow, much less over the course of an entire year.

Having said that, the factors I mentioned (all-Republican government, rising interest rates, etc.) will certainly play a role in how the market performs over the coming year. Exactly where the Dow Jones will end up is anyone's guess.

Matthew Frankel owns shares of American Express and Goldman Sachs. The Motley Fool owns shares of and recommends Visa. The Motley Fool owns shares of ExxonMobil. The Motley Fool recommends American Express, Chevron, and UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.