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INVESTMENT OUTLOOK: 3-6 MONTHS, JANUARY 2017 Introduction Global equities enjoyed a strong fourth quarter, except for emerging market equities, largely because of uncertainty over US trade and financial policy. Global corporate bonds outperformed government bonds. The political and investment landscape has changed considerably since this time last year. Market action suggests we are coming to the end of a multi-decade period of declining long-term interest rates. With more political uncertainty expected in developed economies, beginning with the Dutch election in March, followed by the French election in April diversification in case of adverse market reactions remains critical, as political and economic drivers suggests higher levels of financial market volatility. In this document, we outline our investment outlook for different asset classes and regions for the first quarter of 2017.
Asset Classes: Equities Overall, we are neutral on global equities, which remain attractive versus ultra-low bond yields. We have upgraded Eurozone equities to neutral from underweight. The weaker euro and global reflation should have a positive effect on Eurozone exports. The Eurozone economy has demonstrated resilience recently, with strong Purchasing Managers Index data releases throughout December. Remaining uncertainties in a postBrexit environment are a cause for concern for European equities. The effects of Brexit will be clearer once the UK triggers Article 50 – which is expected in March. There are several key political events over the next year such as elections in Austria, France, Germany and the Netherlands. In fact, nearly 40% of Europe’s collective GDP is voting in 2017. Banks continue to be unappealing because of enduring concerns surrounding the banking systems and litigation in several European countries. The UK economy has remained resilient post the referendum result but uncertainty remains regarding its future relationship with the EU, despite the greater clarity provided by Prime Minster May’s recent positively received speech. Data from the UK has been much better than many analysts initially forecasted. Due to the fall in the value of sterling, we strongly expect UK inflation to increase in 2017. Despite a sterling-induced rise in dividend pay-outs, the underlying market remains unsteady and we remain cautious about investing in UK equities in 2017. We expect that while the EU would be inclined not to be accommodative to the UK in the Brexit negotiations, to discourage any other members from leaving, the scale and importance of trade with the UK will lead to a more reconciliatory stance than many commentators expect.
Emerging market fundamentals have improved in comparison to their status in recent years, and there remains an opening to take advantage of considerable catch-up potential versus the established markets, chiefly in Asian countries such as India where macroeconomic conditions are improving. Our outlook is adverse for Mexico at present, due to US political developments and domestic problems such as weak public finances and internal political uncertainty. Emerging markets that can benefit from higher oil prices are attractive. Cyclical recovery in Russia should lead to an increase in equity prices. Protectionist policies from the new US administration may have a negative effect on some emerging market equity prices.
We retain a positive outlook on Chinese equities due to high consumer confidence and continued steps toward the modernisation of China’s capital markets. We believe lower anticipated growth rates are already more than sufficiently reflected in equity prices. Chinese equities have a better earnings outlook than developed markets and valuations are cheaper than other markets, especially on price-book ratio. This position may change in our next outlook as concerns over capital outflow and the strength of the currency are re-emerging. Our outlook on Japanese equities has moved from negative in our last investment outlook, to neutral this time round. While markets have priced in strong expectations of fiscal stimulus and money loosening, a cheaper yen should drive forward corporate earnings and business investment. We expect that the business cycle that began in 2009 still has at least another two years to run. Among major rich-world economies, the US is in markedly the best position. Favourable employment trends add to optimism on the US economy. Despite the high valuations on US equities at present, we have a positive outlook as dividends and share buybacks are still supportive and equities appear buoyant in the expectation of fiscal easing from President Trump and the shift in investor sentiment. Healthcare and pharmaceutical sectors may experience volatility, due to the revoking of the Affordable Health Care Act and possible future price regulation of medicines.
Asset Classes: Fixed Income Overall, we are neutral on fixed incomes since the Japanese and European asset purchase programs are still in place. The European Central Bank is likely to extend its asset purchases beyond March, whilst tapering in 2017. Concerns about this tapering are likely to mean bond markets are more volatile this year after the rally observed over the last couple of years. Yields remain expensive relative to historical levels. Credit spreads have tightened significantly over the past year. Corporate bonds are typically more attractive than government bonds now, especially high yield debt despite the risk of overcrowding in some sectors. Quantitative easing supports UK Investment Grade Corporate Bonds, but has led European yields to unattractive levels. Political pressures could periodically affect peripheral bond markets, requiring a quick ECB response. The recent rise in bond yields is likely to be contained. The approach of the Japanese central bank and absence of yield make Japanese government bonds unattractive. We would also go underweight compared to our benchmark in US Treasuries due to the tight US labour market, and anticipated interest rate increases in 2017. US bond investors are concerned that Trump’s aim to boost economic growth, via a wide-ranging fiscal stimulus package, will lead to greater inflation and ultimately higher interest rates. As with our last investment outlook, for yield, financials and emerging market credits appear most attractive. Emerging market debt remains attractive, particularly in Brazil and Indonesia which both
have attractive growth-inflation ratios and improved fiscal standings. Dollar-denominated debt is still preferable to local currency debt, both on valuation grounds and on expected dollar movement. On a selective basis, higher yields are attractive in the environment of looser monetary policy.
Asset Classes: Alternative Investments Alternative investments are a key portfolio diversifier. Commodity prices have stabilised; we expect prices to be affected by the strength of the US Dollar and level of demand from China. Overall, we are neutral on commodities but positive on energy. Supply side factors are improving the outlook for oil and industrial metal. The possibility of sanctions being re-imposed on Iran or the nuclear deal, strongly criticised by Trump, being scrapped, could lead to higher oil prices. Real estate has suffered from higher bond yields, but with a continued lack of investments which provide yield, we retain a neutral view. We hold a positive outlook on core European real estate markets, which offer relative good value in the current low interest rate environment. We take a light position on UK real estate due to the prevailing uncertainty caused by Brexit. North American real estate should continue to benefit from the strong position of the US economy. Emerging Asia real estate markets are risky. Japan and Australia remain attractive where returns are driven by rental and capital value growth.
Asset Classes: Currencies In our opinion, after its dramatic fall as a shock absorber after the UK public voted to leave the European Union, despite its recent revival, GBP is currently undervalued and will strengthen in 2017. Catalysts for this could be the Dutch election and the election of a more conciliatory government in the French election. The pound’s recovery is largely dependent on the level of uncertainty and political brinkmanship between the UK and the rest of the EU over the terms of Brexit. We believe the Euro is presently over-valued. Brexit and the election of Trump exemplify strong anti-globalisation sentiment. With several up-coming elections across Europe this presents a number of risks. While a victory for Le Pen appears unlikely, the far-right continues to gain support in France, which could result in a negative effect on the markets. Moreover, Europe looks less well positioned than Japan to cope with the next phase of currency pressures. We would expect the Swiss Franc to retain its strength because of a large external surplus. The US Dollar has rallied since the US Election and will continue to benefit from steady tightening of monetary policy. Conditions have improved for emerging markets. Despite the fall experienced after the US election result, we expect emerging market currencies to perform relatively well over the next six months.
Disclamer This article is provided for information purposes only and is not intended to provide investment advice. This article is sourced from materials provided by relevant financial institutions and data providers. This article presents general information only, and you should obtain your own investment advice appropriate to your specific circumstances and attitude to risk.
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