Welcome to a new year and the pressing market issues facing investors as they look to put money to work and navigate 2017.
Geopolitical surprises upended expectations last year and few predicted that 2016 would end with a global bull market in equities, while bond yields remain relatively low. Will strategists be any better at forecasting this time around? Here are the big questions that will preoccupy investors as the first trading days of the year unfold.
Are markets at risk of a Trump disappointment trade?
Investors have taken a leap of faith that the combination of fiscal stimulus and less onerous regulations for many businesses under president-elect Donald Trump will ignite the US economy and call time on the era of lacklustre growth and slumbering bond yields. In turn, the long-mooted great rotation has begun, with money leaving bonds and flowing into equities.
The S&P 500, Dow Jones Industrial Average, Nasdaq Composite and Russell 2000 of small capitalisation stocks have all hit highs since November 8.
The yield on the 10-year US Treasury, meanwhile, has jumped from a low of 1.32 per cent in July to 2.5 per cent, as bond investors contemplate faster economic growth and higher rates ahead.
Yet is it too much, too soon, especially for a stock market many had judged to be expensive? A stronger dollar also looms over multinational US companies, offsetting cuts in taxes and regulation.
“Wall Street tends to get ahead of itself at times, and this appears to be one of those,” says Jenny Jones, head of US small and mid-cap equities at Schroders. “We do believe [Trump] will achieve many of his goals, but they seem to be close to fully priced now and they could take nine-18 months to accomplish. That leaves a lot of room for disappointment.”
How will Europe and the UK handle Brexit?
It may be only the eighth most traded currency pair, but euro-sterling price action offers a gauge for political risk as well as strong trading opportunities in 2017.
Talk of “hard Brexit” in which the UK forgoes single-market access to have full control over its borders has resulted in investors marking down the value of UK assets — selling the pound — and has cast doubt over London’s position as one of the world’s biggest financial centres.
Weakness in the euro against the pound on the back of Brexit developments would suggest a reduction in investors’ Brexit risk premium. Steven Saywell at BNP Paribas believes euro-sterling will fall. “Sterling is at an extreme pricing, it is vulnerable to positive surprises and a weakening in hard Brexit,” he says.
An outlandish prediction from Saxo Bank even has the euro falling to 73p on the basis that the EU will be forced by migration pressures in Europe to cede ground to the UK.
There is also the matter of what Brexit means for the future of the euro with France, Holland, Italy and Germany holding elections in 2017. If anti-euro movements gain the upper hand elsewhere, even Germany may reassess saving it, say Deutsche Bank group’s chief economist David Folkerts-Landau and chief German economist Stefan Schneider. “The pros of a single currency probably outweigh the cons for Germany — not least because its own currency would massively appreciate.”
Will the oil market balance?
Oil supply from the world’s biggest producers will be in focus from the first trading day of January as market participants assess the extent to which countries such as Saudi Arabia and Russia reduce production following a global deal to cut supplies for the first time since the global financial crisis.
There will also be keen interest in the return of US shale oil and the sustainability of supply recoveries by Libya and Nigeria, conflict-ridden nations that were left out of the output cut agreement.
The outcome of these unknowns will determine when oil supply and demand come into balance in 2017 and whether prices will remain above $50 a barrel. “Until we start to get answers, the debates will continue,” says Michael Wittner at Société Générale. “Until then, we believe that markets will enter a ‘wait and see’ mode; crude prices are likely to start trading within a relatively wide range”.
If Opec members and co-operating countries such as Russia succeed, they could finally draw down tanks brimming with excess crude — helping to end the commodity supply glut. The Bloomberg Commodity Index (BCOM), a basket of 22 futures contracts, rose nearly 12 per cent in 2016, its first annual rise since 2010. Alongside oil, industrial metals such as zinc and copper have also been climbing on hopes that stronger global growth will underpin demand.
Are global banks investable once more?
Banking equity indices in Japan, Europe and the US posted double-digit gains in the second half of 2016, marking a change of fortunes from earlier in the year when the sector was beset by worries about profitability erosion amid low and negative interest rates, strict regulation and fines for bad behaviour.
According to investors, one of the most important causes for optimism is the prospect of higher interest rates on stronger economic growth as policy gears switch from monetary to fiscal measures in the coming year. Rising long-term bond yields help banks by boosting their net interest margin — the difference between the rates on their borrowing and lending. “We remain broadly bullish on banks as a sector,” says Mark Dowding, partner at BlueBay Asset Management.
But the rebound will face a stern test, particularly in Europe where the health of the sector is in question. European banks are on course to be worth 0.68 times analyst estimates for the book value of their assets at the end of 2016. For all the share price movement, the valuation is less generous than it was a year ago.
Are financial conditions going to be tighter?
The last time there was a substantial and rapid rise in US government bond yields was more than two decades ago — in 1994. At the time, much of the financial world failed to anticipate the speed and pace of rate increases announced by the Federal Reserve — which led the yield on 10-year Treasuries to jump 2 percentage points in the space of five months.
Complacency this time around may be of a different kind. Investors appear to see a pro-growth Federal Reserve under Janet Yellen and expect three more rate raises in 2017.
Philippe Ithurbide, global head of research for Amundi Asset Management, says: “It is difficult to understand the message: how to have at the same time stronger growth, a weaker dollar and a more restrictive monetary policy?”
Real economic growth in the US is running at about 2 per cent, as is the rate of inflation, while the unemployment rate is low, figures that would have normally suggested a much higher level for interest rates. Should the Fed move too fast the repercussions could be severe. Six of the 12 tightening cycles since 1945 have resulted in a US recession within two years.
Has the EM tantrum got further to run?
Donald Trump’s election win intensified a rout in developing economy assets that spurred net redemptions from emerging market equity and bond funds at a pace not seen since the US bond taper tantrum of 2013.
The Mexican peso and Turkish lira plumbed record lows, as the post-election “Trump trade” spurred a stronger dollar and higher bond yields.
Only Russia appeared to escape the trend, thanks in part to discernible warmth between Donald Trump and Vladimir Putin.
With capital flowing out of China in spite of efforts to stem it, and markets expecting further US rate rises in 2017, the largest investors in emerging markets are focusing on differentiation and “managing risk”.
“Questions remain with respect to how a Trump administration will deal with issues of trade and protectionism and whether campaign promises in relation to tariffs and trade deals materialise into something significant,” says Pierre-Yves Bareau, head of emerging market debt at JPMorgan Asset Management.
Will there be more public market listings?
The recent dearth of listings made last year the slowest for US IPOs since 2003 — but there are hopes of a rebound.
“There will be a significant pick-up [in listings] in 2017, and this will probably become most evident in the second quarter,” predicts JD Moriarty, head of Americas equity capital markets at Bank of America Merrill Lynch.
Bankers say the post-election equity rally and positive performance of 2016 deals bode well for a pick-up in activity next year. In contrast to 2015 deals, which ended that year down 6.5 per cent, 2016 listings are up on average by about 20 per cent, according to Dealogic.
There is also hope for a revival of tech initial public offerings. The hottest tech companies have avoided public markets in recent years, instead raising billions of dollars at attractive values privately.
Snap, the messaging app, is preparing for what is expected to be one of the largest tech listings in years as early as March. It is hoping for a valuation of $20bn to $25bn. If successful it could lure other tech “unicorns” — private tech companies that have achieved valuations of $1bn or more — to test the public markets.
Reporting by Elaine Moore, Dan McCrum, Roger Blitz, Nicole Bullock and Anjli Raval
