POLITICS has dominated the newspaper headlines in 2016, led by the decisions of voters in the UK, US and, most recently, Italy.
Next year looks to be similar, with elections due in the Netherlands, France and Germany. Don’t spend too much time reading the front page though - the business pages will be rather important for investors who need to focus on the fundamentals before they decide whether it is a good or bad idea to buy or sell a stock, a bond or a market.
For some time we have been warning about the world of low numbers. Longstanding headwinds to the world economy such as poor demographics, weak productivity growth, insufficient infrastructure spending have combined with cyclical ones – globalisation, continued purchases of government bonds by central banks – to create an unfortunate combination of low growth, low inflation, low interest rates and low bond yields.
These potentially add up to lower returns for financial assets over the medium term.
For 2017, however, there is the possibility that economic and political cycles will coincide to give better returns. The good news is that we had forecast a moderate upturn in global activity into 2017 even before the US election outcome led to a positive reassessment.
Although the details of Trump’s policies are still to be spelled out, there is the potential for a series of major tax cuts and spending increases. What does this mean for companies? Analysts have been forecasting global profits growth of ten to 12 per cent next year and while some downgrades are likely, we still expect a positive outcome.
How positive will be determined by the complex relationship between wages and productivity growth, changes in energy costs, regulation and taxes, as well as the extent of any further rise in the US dollar. A complex mix clearly - I never said successful investing would be easy in 2017.
One of the major features for headline writers in 2017 will be a series of articles about ever-rising rates of headline inflation. The explanation is simple – in most countries the base effects from previous declines in energy prices are falling away, exacerbated by OPEC’s recent agreement to limit supply.
In the UK, the impact on import prices from the decline in the pound will become more apparent, even if restrained by a continued supermarket price war. Fiscal expansion and immigration policies under the new Trump Administration could add to upward pressures on inflation - the unemployment rate is already rather low in the US.
How will central banks respond? The answer is that they will all look through temporary moves up in headline inflation and instead focus on the core rate, excluding therefore volatile items such as food and energy.
The reaction of businesses and households also matters - can companies drive forward with productivity improvements or will corporate margins start to come under pressure from rising costs? The only central bank likely to tighten monetary policy in 2017 is the US Federal Reserve. We expect at least two more moves after this week’s increase.
Bond markets will face a tug of war therefore, with yields pulled higher by events in America but restrained by the slow growth world and continued quantitative easing seen in other countries.
How to invest against this backdrop? All in all, we see opportunities across asset classes where better corporate cashflow will sustain valuations - a mix of developed market equities, global real estate and higher yielding company bonds.
Financial markets are at an interesting juncture. Recently there has been a rotation away from expensive dividend-yielding stocks towards more cyclical sectors, including financials. Steeper bond market yield curves are giving a clear signal about sector choice.
In light of the US election, US equities are more attractive as long as the focus of the new administration is on fiscal rather than trade policy. Currency moves will really matter for other equity markets, say the UK or Japan.
Sustainable yield remains a relevant investment theme, but the key word is sustainability especially for those markets where pay-out ratios are stretched.
Andrew Milligan is head of global strategy at Standard Life Investments
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