The Lowdown on Markets to 6th January 2017
World Markets at a Glance
In this week’s issue
- Throughout 2016 global investors had to endure a roller coaster ride from the markets.
- UK Investors with a global asset allocation benefitted from the depreciation in sterling.
- Both Brexit and the US Presidential Election acted as a tailwind for global equities.
- We saw a substantial recovery in the energy and commodity markets throughout 2016.
- From an investment perspective markets were very supportive of risk assets in 2016.
- Shifts in fiscal policy and populist politics will likely feature high on the agenda for 2017.
“The Global equity markets continue to rally on signs of economic recovery”
Throughout 2016 global investors had to endure a roller coaster ride from both an economic and political perspective. In the first quarter of the year the markets were clearly focused upon China’s economic slowdown, which led to a lacklustre period for most stock markets. Then as we moved ever closer to the 23rd June, the financial markets began to show some anxieties over the UK electorate vote on the European referendum, which in turn, saw the Vix Index, the investors fear gauge, rise by nearly 100 per cent.
Of course the markets then became rather perplexed by the UK no vote, falling aggressively post-Brexit, however, they then rallied again on the understanding that the invoking of Article 50, to start the exit proceedings, would not happen until the first quarter of 2017.
With that in mind, the financial markets then changed its focus towards the United States, and the approaching presidential election in November. But like Brexit, we then experienced a shock result as Donald Trump became the new US president elect beating a beleaguered Hillary Clinton to the White House.
Curiously, the financial markets and investors reacted positively to this result believing that under the new Trump administration they would be getting the most pro-growth, pro-business and reflationary president in a generation. Clearly, the promise from the new president elect that he would cut US corporate taxes, announce a huge infrastructure spending programme, review the current regulatory system, and introduce some new protectionist policies has won the majority of the voters over, but of course, he still needs to get these astonishing policies through Capitol Hill.
“Throughout 2016 global investors had to endure a roller coaster ride”
Immediately after the US presidential election the US Federal Reserve Bank announced that they would raise interest rates for only the second time in a decade, with the chair, Janet Yellen, stating that the banks decision to raise rates should be seen as a reflection of the confidence that they have in the progress made in the US economy, and that further interest rate hikes should be expected in 2017.
Unquestionably, their continued push for full employment, the probability of higher inflation and wages under the Trump administration is likely to see the central bank be much more pro-active in the years to come, and of course the current chair, Janet Yellen, will see her tenure come to an end in February 2018, which in turn, will see extensive changes within the Fed board.
Then in December the Italian Prime Minister, Matteo Renzi, experienced a humiliating referendum defeat, which led to him announcing his resignation and leaving Italy facing political and economic uncertainty. Clearly, Mr Renzi staked his political future on an attempt to change Italy’s cumbersome political system but the referendum was more than just a vote on constitutional reform, it became a chance for the people to vote and reject establishment politics and was a resounding victory for the No camp, a medley of populist parties headed by the Five Star Movement.
“A further period of political uncertainty is likely, similar to what happened in 2016”
Now moving onto the New Year, a further period of political uncertainty is likely, similar to what happened in 2016. This could create a shadow of concern over Europe as the forthcoming elections in Germany, France and Holland all take place. Rising populism and policy divergence might generate further fears within the Eurozone, perhaps fuelling a period of Brexit-type anxieties, and a higher level of market volatility. We will also see a continuation of extensive debate over the future exit of the UK from the European Union.
And of course, in respect to the central banks we are already seeing a change of direction in respect to those policies used throughout the financial crisis, such as negative interest rate, fiscal stimulus, and quantitative easing programmes, indeed, the Fed have already become more hawkish by raising interest rates in December, and pre-warned of further rate hikes to come in 2017. Equally, in Europe and Japan, the European Central Bank, and the Bank of Japan, has both announced material changes to their current QE programmes. Likewise, in the UK the Governor of the Bank of England and their chief economist have both been vocal by admitting that they made errors in their actions post Brexit and previous forecasts.
Clearly, a decade after the financial crisis, which has seen central bank’s create a landscape of low inflation, interest rates, bond yields, and anaemic global economic growth, we are now seeing some signs of a recovery, led by the US. Indeed, the battle with deflation in many parts of the world would now seem to be over, with broad-based inflation seemingly on the rise. Indeed, in the US more than half of the goods in their Consumer Price Index basket have now risen above their average historical rate, which is the first time this has happened since 2008. In the Eurozone headline inflation has hit a two-year high, whilst core inflation is largely moving sideways, and in the UK the weaker pound has seen UK inflation spike up, whilst China’s Producer Price Index has moved up out of five years of deflationary period.
“In the Eurozone headline inflation has hit a two-year high”
Unquestionably, we are now moving into a “new paradigm” which is likely to see a normalisation of interest rates, bond yields, and inflation, but this is likely to happen over an extended period given that we still have an unstable global economic economy which could easily be de-railed again very quickly either through a political event or an incorrect course taken by the central bankers. Also we cannot ignore the fact that asset bubbles have been created from years of loose monetary policies.
Understandably, there are now some distinguished investors that believe that after an eight year bull market, the second longest in financial history, a stock market crash is imminent and that US stocks in particular are overvalued, in fact, they believe that they are as risky as they were in 1929 and 1999. However, the real difficulty at the moment is that the markets are still benefitting from the “Trump trade” and with cash returns so low, and bonds looking unattractive against equities, the probability of the equity markets moving higher is still feasible.
“We live in a world full of unknowns”
Also the likelihood of the global economy surprising on the upside is very possible, even if it’s only for a brief period. Therefore, global investors must become more selective in the investments over the coming months and years and ignore much of the daily noise that surrounds the markets. Our emphasis has always been to invest on a long-term time horizon investing primarily through those fund managers that demonstrate excellent stock picking qualities by investing into those companies that have sustainable top-line growth, translating that into profits, have free cash flow growing their dividends, but without excessive financial leverage.
Regrettably, we live in a world full of unknowns and consequently this can have a short-term detrimental effect on our investment philosophy but if we do gradually move back into a period whereby fundamentals move stock and bond prices rather than central bank intervention then the financial markets will adjust themselves accordingly and quality businesses will still offer investors attractive returns over time.
And finally to conclude, we did see US equities climb to a new record high last week with the Dow Jones Industrial Index tantalisingly close to that magical 20,000 level as investors began to digest a broadly encouraging US employment report. We also saw the US dollar rally whilst Treasury bonds sold off in favour of equities.
Clearly, it was not just the US jobs report that spurred the US equity market higher, indeed, a solid manufacturing and services sector report, plus comments from Federal Bank Reserve officials stating that expansionary fiscal policies under Donald Trump might mean economic growth could exceed their forecasts and help to elevate Wall Street.
Understandably, with US wage growth climbing, positive economic data, and a big fiscal stimulus package expected in the second quarter of this year, assumptions are already being made that price inflation will rise above the 2 per cent water mark, which in turn, would suggest that further interest rate hikes will follow in quick succession.
“Economic growth could exceed forecasts and help to elevate Wall Street”
In the UK the FTSE 100 Index secured its fifth successive weekly advance closing above 7,200, and of course, with some analysts predicting a pick-up in future earnings growth because of the weakness of the pound the market could track much higher, but this would be dependent on the companies that make up the banks, healthcare, miners and energy sectors given that they represent nearly 50 per cent of the index.
Overall, there are still some opportunities left in the markets but what worked in the last decade is unlikely to work in the next, therefore, active asset allocation is probably the order of the day given that both the political arena and central bankers are beginning to change course which will have big ramifications for global investors and the markets.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum, he worked within a larger asset managers, primarily as an Investment Director with Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority .
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