January 2017 market view: Global markets react to Trump

statue in front of american flags

Investing

Andrew Milligan

8th February 2017 at 5:47pm

As the aftershocks of political events across the world from 2016 begin to subside, Andrew Milligan, Head of Global Strategy at Standard Life Investments, takes a look at global markets in 2017.

He also considers the important issues we need to monitor when assessing market movements: it’s not all just politics and economics.

Global markets rise in response to Trump

As we were all aware, there was an air of significant uncertainty after the US election. The result wasn’t what many people had expected.

However, once the dust began to settle and we realised that the Republicans had retained their majorities in both the House of Representatives and the Senate, hopes began to rise of a business-friendly administration.

There was further optimism as Mr Trump started to appoint his Cabinet: markets began to look ahead to substantial tax cuts and significant deregulation which could boost the US economy, increase wages and inflation, and support company profits.

As a result, we saw share prices, the US dollar and US government bond yields all go up.

Now we’re into January, we’ve witnessed markets beginning to mark time as they wait for new information. For example, will Mr Trump concentrate on policies closer to home or will some of the concerns about trade barriers take the edge off investor confidence? The Dow Jones index breaking up through 20,000, however, shows investors are seeing the glass half full.

Interest rates and inflation in the US

The US central bank, the Federal Reserve (the Fed), has been content to maintain low interest rates since the last recession.  A strong dollar has helped to restrain any inflationary pressures while unemployment has taken a long time to fall.

However, we see a new cycle appearing.  Wages in the US have accelerated, meaning the Fed may need to do more work trying to keep the economy running smoothly and limiting inflation.

Indeed, it may have to increase interest rates a few times in the next couple of years, but policy announcements from the Republicans about tax cuts could result in the Fed having to take a more forceful approach to maintain a balance.

What does Brexit suggest about the stability of the pound?

It’s important to follow political and economic news when trying to understand market movements, but it is also important to understand how investors are positioned: are they broadly neutral on any asset or have they already adopted a critical stance one way or the other?

Before Mrs May’s speech on 17 January, there were some very large underweight positions in sterling, so greater clarity about what the government wanted encouraged some investors to close those positions and become more neutral, perhaps even overweight.

Going forward, we still expect sterling to be a volatile currency.  It’s likely to continue to react to a mixture of economic developments, political risks and the underlying fragility of the UK, which needs sizeable capital inflows to balance a large current account deficit.

Are UK bonds heading towards a bear market?

Government bonds in the UK, and indeed most other countries, face several headwinds in 2017.

Headline inflation should rise quite noticeably – partly as commodity prices (such as oil) are rather higher than a year ago and partly as currencies have been falling against the US dollar, sharply, of course, in the case of sterling.

We expect these pressures to be offset to some extent – for example, how much do shops and supermarkets face a squeeze on margins rather than passing the costs of more expensive imports onto the consumer?

However, headline yields on UK gilts and corporate bonds look to be rather lower than the inflation figures we expect to see in 2017, so investors look to make a real loss in the coming year.

Looking further ahead, 2018 will be rather different as the one-off effects of higher oil prices are expected to fall away. So headwinds for gilts look rather likely for a short period of time – of course any gilt investor needs to decide how long they wish to hold their bonds for.

What might be the key assets in 2017?

Our favoured asset classes are a mixture of equity, currency, bonds and property.

As I mentioned before, the new US government looks like it should support business. If the administration focuses more on boosting the domestic economy than it does on criticising overseas government about trade arrangements, we would expect to see the economic cycle improving even more.

However, investors will still need to seek out income.  At Standard Life Investments, we believe that the US economy is the only major one that’s likely to raise interest rates this year or next.  Therefore, our preferred assets would include not only US equity and the US dollar, but also high-yielding corporate bonds and European commercial property for their income.

Takeaways from the World Economic Forum (WEF)

The WEF in Davos was rather overtaken by a range of other political events: the reverberations from the Italian referendum, Brexit developments, as well as the run up to the inauguration of Mr Trump.

Nevertheless, there were some useful sessions at the event. For example, there was a focus on the fourth industrial revolution, so more politicians and businesses were briefed on the risks and opportunities from automation and artificial intelligence as these reach into a wider array of sectors.

Beyond the WEF, it’s clear that authorities finally appear to understand that continued and sustained expansion is required to get the world out of the stop-and-go cycle it’s been in since 2008.

At Standard Life Investments, we continue to see sustainable yield as a key investment theme.  At the same time we’re looking for selected growth opportunities as the profits outlook appears better in 2017.

If you have any questions about your investment strategy, your financial adviser will be happy to help.

The views expressed in this blog 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. Published January 2017.