Who at the start of last year, when stock markets globally were panicking, would have bet that all three major US indices would achieve record highs in 2016? Many fund managers expect more of the same this year. The US was selected as the country likely to deliver “the strongest gains” in a survey conducted by the Association of Investment Managers. US profits “seem certain to rebound” if President-elect Donald Trump’s administration “pushes through corporate tax cuts”, said The Economist. But “a lot of good news is priced in”. Robert J. Shiller of Yale reckons that the cyclically adjusted price-earnings ratio is currently 70% above its long-term average. Meanwhile, the three interest rate rises pencilled in by the US Fed “will reduce the dollar value of foreign profits for American multinationals”. There are also fears that Trump’s promised fiscal boom may be derailed by hawks in Congress. “Wall Street tends to get ahead of itself at times, and this appears to be one of those times,” said Jenny Jones of Schroders in the FT. Markets are at risk of a big “Trump disappointment”.
Much depends on Brexit negotiations. Talk of a “hard Brexit” – in which the UK forgoes single-market access – has kept the pound down after the initial referendum shock: it is still some 20% down on its value a year ago. That may well boost the number of foreign acquisitions of British companies this year; it may also have an adverse effect on UK growth if household incomes are squeezed by higher inflation. An FT poll of 122 economists found that most expect growth to slow sharply from around 2.1% in 2016 to no more than 1.5% in 2017. Still, some believe the gloom surrounding the pound is overdone. “Sterling is at an extreme pricing, it is vulnerable to positive surprises” – particularly to a softer Brexit, says Steven Saywell at BNP Paribas. Saxo Bank goes even further, predicting the euro could fall to 73p on the basis that the EU will be forced by migration pressures in Europe to cede ground to Britain.
Given the FTSE 100’s heavy exposure to mining stocks and oil companies, much rides on this question for UK investors. “A substantial proportion of the surge in the FTSE 100 in 2016 was driven by the outperformance of just two stocks – the oil giants BP and Shell,” said Jeremy Warner in The Sunday Telegraph. The recovery in mining stocks made the index “largely immune to worries about the impact of Brexit on the UK economy”. I’m bullish about commodities, said John Stepek in MoneyWeek. After an “epic” five-year bear market, “it would be surprising for things to turn bad again so rapidly”. The consensus among oil pundits is that the black stuff will stay above $50 barrel, owing to Opec’s deal to cut production.
With France, Holland, Italy and Germany all holding elections in 2017, the risk of another populist shock is high. In the “quite unlikely but absolutely possible” event that Marine Le Pen wins in France, “it would probably mean the end of the eurozone and the EU”, said the FT. And Angela Merkel is not assured of keeping her job either. “Without her, a financial conflagration – a bank bailout, say – becomes harder to manage.” Nonetheless, investors are taking an optimistic view, said Philip Aldrick in The Times. A rebound in manufacturing at the end of last year suggests that recovery in the bloc has “gathered momentum”. Investors have duly shrugged off political anxieties to push the Euro Stoxx index to its highest level since late 2015. In another show of confidence, government bond yields in the eurozone’s troubled peripheral states have also fallen sharply. The biggest worry of fund managers polled by Bank of America Merrill Lynch is that of EU disintegration, said The Economist. But Europe might well be “a dog that doesn’t bark”.
Trump’s election and the US Fed’s decision to raise interest rates “has been hailed by some as the start of a new era for central bank policy”, said Citywire – with important knock-on considerations for the bond market. Since Trump’s election, US Treasury bond prices have tumbled as investors anticipate faster rate rises. Yields, which move inversely to prices, have shot up in both the US and Britain; barring a big shock to the global economy, BlackRock’s strategists reckon “the only way is up” this year. Luca Paolini of Pictet Asset Management agrees, seeing the scenario for bonds and dividend-paying stocks as “pretty grim”. Yet some reckon government bond prices may surprise on the upside. Much depends on what politicians do next, said John Stepek. “Will they really start spending? Or will we see another deflationary scare before too long?”
After the carnage of early 2016, emerging market stocks broadly outperformed expectations. But Trump’s election and the prospect of a stronger dollar this year may bode ill for many territories, said the FT. With capital flowing out of China, despite efforts to stem it, and markets expecting further US rate rises, the largest investors in emerging markets are focusing on “differentiation” and “managing risk”. Russia remains widely tipped, thanks to the “discernible warmth between Donald Trump and Vladimir Putin”. But the big question is how a Trump administration would deal with issues of trade and protectionism, said Jeremy Warner. Were the Donald to “go through with threats to tear up the global trade system”, there’s potential for “catastrophic damage”.
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