Politics developed a nasty habit of gate crashing the markets in 2016. The UK’s decision to leave the European Union (EU) and Donald Trump’s victory in the US presidential election, was, for some, like opening the door to an uninvited and unwelcome guest at a party that was going just fine without them. Expect more of the same in 2017.
While the first 100 days of Donald Trump’s presidency will be closely scrutinised for policy initiatives, Europe is likely to move centre stage next year with national elections in France, Germany and the Netherlands. The outcome of these votes may seal the victory of anti-establishment, anti-globalisation forces that have played such a large part in the outcome of the Brexit referendum and Trump’s election to the White House. Meanwhile, as these elections play out, the EU and the UK will have to deal with the consequences, intended and unintended, of Brexit.
As politicians in the West have seized on globalisation as a cause for their country’s economic ills, the calls have grown louder for governments to protect local industries and jobs from foreign competition. The implementation of protectionist policies, while a cause for concern, would, in my view, have only a limited impact in the dematerialised world we now live in, where so much trade is in services and takes place on the internet. Emerging economies may have more to fear especially in light of Donald Trump’s calls for 45% trade tariffs on Chinese goods but even here, there is reason to be hopeful given over half of all Asian trade is done within the region. As for concerns emerging market currencies may yet fall further in the face of a strengthening dollar, raising the cost of servicing debt which was borrowed in dollars, I believe many of them have already fallen quite substantially this year, pricing in the expected rise of the US currency. It’s a decline though that has been welcomed by emerging market exporters, who have benefited from being able to sell more competitively priced goods.
The health of the Chinese economy does however remain key to Asia’s prosperity. There is certainly enough evidence to suggest that China is muddling through and working hard to manage its debt levels, even as the country’s trend growth rate slows. Commodity prices such as oil are showing a bit of resilience, and that is due in part to sustained demand from China as it continues to expand.
As for India, the region’s other big economic giant, it is likely to see some short-term disruption from de-monetisation – the government’s decision to withdraw 500 and 1,000 rupee-denominated notes almost overnight and issue new ones – but the likely implementation of a Goods & Sales tax in April 2017, and the potential for lower interest rates in the next 12 months should bode well for the country.
For developed markets, Donald Trump’s plans to use tax cuts and large increases in infrastructure spending to boost the US economy, seems to be sending a clear signal that government fiscal stimulus and not central bank monetary policy should now do the heavy lifting to galvanise the economy. The UK government has also been making similar noises to that effect. Bond markets have reacted accordingly, with prices tumbling and yields rising on the expectation all this fiscal stimulus will lead to greater inflation. The question remains whether the sell-off in the bond market actually marks the beginning of the end in the 35-year bond market rally. It could well be that the low in bond market yields has been reached and we see more range-bound trading for bond prices in 2017.
For stocks, inflation expectations are also likely to influence outcomes in 2017. Since the end of the global financial crisis of 2007-08, asset prices overall have done better than most people would have expected, with valuations at the top of end of their historical ranges and stocks being viewed as cheap relative to bonds. The return of inflation should benefit sectors such as banks, which will earn more as central banks start to lift interest rates to keep a lid on rising prices, but also the metals, mining and energy sectors as a pick-up in economic growth boosts demand for their products. To some extent, what we are likely to see is a continuation of the reversal of the “growth trade”, where investors for many years have preferred to buy shares in companies that are growing faster than their overall markets and plough profits back into their businesses to expand them, in favour of so-called “value” stocks, where the current share price may not fully reflect the real value of the company.
In short, the last year has shown us that the consensus around the benefits of the market economy has frayed at the edges. Investors may now need to adapt to a new political reality that is only just starting to take shape, and as it does, we should expect a period of heightened volatility for the markets. Investor sentiment remains both nervous and cautious, especially in Europe where we have seen appetite fall away for risk assets – assets such as stocks, commodities and certain types of bonds where there is a lot of price volatility. We have also seen a drop in the number of companies looking to go public – a further sign of nerves. That said, investor reaction appears measured rather than panicky and that is an encouraging sign heading into 2017. Against this backdrop, the case for active asset management, where fund managers use their expertise to analyse companies in depth and select stocks or bond that should perform well whatever the market conditions, remains in my view as relevant as ever – if not more so in today’s Brave New World.
This commentary is for informational purposes only and is not investment advice. The views expressed are those of the author at the time of writing and are not necessarily those of Jupiter as a whole and may change in the future. Every effort is made to ensure the accuracy of the information but no assurance or warranties are given. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested.
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