Investment View December 2016 / January 2017
A bit of an understatement to report that 2016 has proved to be an unusually turbulent year, with sharp reversals in prevailing trends and sentiment.
The year opened with some alarming views being expressed. Many may remember the dire warning that investors face a “cataclysmic year” where stock markets could fall by up to 20% and oil could slump to $16 a barrel. This was the stark view of economists at the Royal Bank of Scotland. Andrew Roberts, RBS’s credit chief, said: “China has set off a major correction and it is going to snowball. Equities and credit have become very dangerous …..” Perhaps this was the harbinger of the expert forecasters, who managed to deliver a degree of consistency throughout the year rarely seen. Consistently wrong. We should have remembered the words of John Kenneth Galbraith “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”
In the first half, initial concerns about a sharp slowdown in the global economy were replaced by those related to the UK’s vote to leave the European Union. In contrast, recent investor sentiment towards equities improved markedly after the Trump victory in the US presidential election, with his proposals around fiscal stimulus and protectionist policies being viewed as reflationary for the US economy. This makes US domestic businesses relatively attractive and this is reflected in the new relative highs such stocks have been hitting. The outlook from most fund houses is very positive about the US in 2017, but we are still to find out exactly what Donald Trump’s administration can deliver.
In the short-term, the prospect of a stronger US currency and protectionist measures has put the recovery in Emerging Markets on hold. This is likely to be temporary, as it is difficult to see wide ranging anti-trade measures. However, China remains an important part of the picture. It has come through this year without incident and as Old Mutual suggested early in 2016, surprised on the upside but 2017 could bring new concerns. In addition, while there are expectations that higher US interest rates, likely 3 rises in 2017, will cause a further strengthening of the US Dollar, the currency has come a long way in recent years and may offer limited upside.
Property has now substantially got over the shock of Brexit and regained much of the ground lost through the rush caused by panicking investors to head for the door. The draconian valuations that we saw post Brexit have substantially reversed and this asset class should deliver very acceptable income through 2017. Consensus views suggest that capital growth will be fairly muted.
Elsewhere, Japan remains a “value” market. Having profited from both domestic reflation plays (immediately after Abe’s election at the end of 2012) and exporters (during periods of Yen depreciation), fund houses are now on the lookout for domestic growth names which have lagged similar stocks elsewhere in the world. It is also a good hunting ground for technology innovators and disruptors particularly in the smaller company sector.
Another currency that has seen volatility this year, Sterling, appears to have stabilised for now. Higher inflation has not yet kicked in but the UK economic outlook remains uncertain. The dire predictions on the economy following a leave vote did not, so far, come close to reality. The reality, though, is that we are not even at the starting line for Brexit. Many FTSE 100 companies benefited from the impact on Sterling, which is unlikely to be repeated through 2017. Equally, it is unlikely to be reversed.
Continental Europe has emerged as the loser out of political events this year and faces election uncertainties in coming months. No doubt the forecasters will be making some interesting predictions regarding each of these elections, but surely we must treat them with considerable caution. These elections will be very significant for the solidity or not of the European project and if populist parities pull off victories then all bets will be off and a rethink will be surely inevitable. The chart that follows offers some visual explanation why popular parties are gaining widespread support across the developed world. This chart is not unique to the US but its shape and size is reflected in most developed economies. The politicians are not delivering for the huge majority and change is demanded. Populism does not look as though it will go away as the world has become skewed as it was after the great depression.
Market valuations in Europe remain polarised, with defensive stocks still trading at full valuations and cyclicals reflecting pockets of value. Sentiment amongst the fund houses varies too. Some see it as a region to be wary of, whilst others see it as offering substantial value and the best global developed region to achieve decent returns through 2017. We are in the latter camp.
Fixed income will remain a challenge, with many now suggesting its 30 year + Bull Run is over. Rising interest rates significantly impact values and we seem to be heading into a rising market, but that is no great shock. High Yield still looks worthy of support as do strategic bonds but we might see more money heading to investment grade bonds. There remains little appetite for Government bonds and that view is pretty much universal.
It’s uncomfortable to admit that we don’t know much about the future, but it is essential. Whether it is about politics, economics or financial market developments, the conclusion is similar. Events such as the US election or Brexit and their aftermath should serve as reminders of this, but humans are wired to ignore the lesson. Instead of taking our repeated surprises as signs that maybe the forecasting game isn’t for us, we quickly forget just how surprised we were and get back to making new forecasts. For investors willing to look through this and focus on what really matters, there should always be opportunities.
Many use terms like “risk off behaviour” and “safe havens” without specifying any further. Most of us employ a rule of thumb based on our own experience, and normally refer to assets like Treasuries, gold and the Japanese yen as beneficiaries in “risk off environments.” This has not been the case in 2016. This is a reminder that the safest assets should be the ones we are most confident in delivering a positive return over our investment horizon, not those which we expect others to buy at certain times.
We wish you a prosperous 2017 from all of us at Intelligent Pensions.