5th January 2017 at 11:58am
By Andrew Milligan, Head of Global Strategy at Standard Life Investments.
2016 saw political headwinds changing as some Western democracies took a step towards populism – but will this trend continue in 2017 and what will it mean for investors? As we move into the New Year, I consider the key challenges that lie ahead and look forward to what’s next for financial markets.
Political strains to continue
As France, Germany and the Netherlands prepare to go to the polls in the coming year, and Mr Trump enters the White House, we fully expect that political strains and stresses will continue to affect a wide range of European countries and other parts of the world.
There are a number of deep-seated causes for the changing political sentiment. These include high levels of unemployment, weak growth in people’s incomes in real terms, difficulties in buying housing and, importantly, the feeling that the establishment doesn’t understand or want to deal with the problems facing ordinary men and women.
Populism is displaying itself in different ways in different countries, but essentially it’s reinforcing an environment where governments find it very difficult to push through the structural reforms which many economists argue are necessary to increase long-term economic growth and the living standards of many households.
Article 50 and the stock markets
Markets are always forward looking, so an announcement in March 2017 that the UK government is triggering Article 50 won’t come as a surprise. However, negotiations are likely to be highly complex, both on transitional rules and regulations, and even more so on the final nature of the UK’s relationship with its European Union (EU) neighbours. Volatile markets in March 2019 would not be a surprise as Article 50 talks come to a conclusion.
What’s next for emerging markets?
2016 was your classic year of two halves for emerging markets – or to be more precise it had several good quarters until the US election led to a radical reappraisal.
In the first phase, record low bond yields around the world encouraged a rush into higher yielding assets – this included emerging market bonds and equities. However, the Trump election has sparked a complete change in views, partly because prospects for the US look rather better and partly because of Trump’s views on trade policy and immigration. As a result, investors have quickly shifted away from emerging markets and into developed market assets.
Looking into 2017, we’d expect some emerging market economies to benefit from a pick-up in global growth and demand for commodities – look out for an increase in global trade as a signal.
On the other hand, a large number of indebted emerging market countries will find life more difficult as the US raises interest rates and the value of the US dollar rises. Country selection is key.
Outlook for global bond markets
Bond markets are reacting to a change in outlook for economic growth and inflation. The signs of an upturn in business activity were already present in 2016 but the Trump election has turbocharged this view.
We expect easier fiscal policy, in particular tax cuts for businesses, to boost the US economy, and money markets are starting to price in 7-8 interest rate moves by the US Federal Reserve (the Fed) over the coming two years. While much of this has been priced into expectations for bonds already, we think there’s still room for investors to sell bonds and buy riskier assets such as equities.
However, we don’t expect an aggressive sell-off – this is still a world where central banks in Europe and Japan have very sizeable quantitative easing programmes, buying bonds in their countries. As a result, this will encourage investors in these regions to search for higher yielding bonds elsewhere – the US will look very attractive.
Currency to play a key role
Currency was a big driver for UK investors in 2016 and we expect currency movements to be important for many markets in 2017, not just the UK.
With an improving economy, higher interest rates, and tax changes which could encourage US companies to repatriate cash held overseas, it seems all the conditions are falling into place for a rise in the US dollar against most currencies.
How sterling and the euro perform against the dollar will probably reflect political rather than economic factors. While neither the UK or EU economy looks to be doing very well, both will face that series of political challenges in 2017, including elections and Brexit negotiations.
How will 2017 evolve?
As we move into 2017, we expect a period of time when investors look favourably on the improvement in the US economy and thus prefer US shares. This will put an end to the profits recession and allow a better balance between fiscal and monetary policies in many countries.
However, as I’ve already highlighted, there are key political risks over the next year, not just related to elections, but also the relationships between the US, Russia, China and key countries in the Middle East.
The tension between the US Fed starting to tighten monetary policy while other central banks keep policy easy could also lead to volatility in bond and currency markets.
At Standard Life Investments, our portfolios have taken on more risk as we prepare for the year ahead but understandably we remain far from having high levels of risk.
The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your investment can go up or down, and may be worth less than you paid in.