Outlook 2017: Global equities
- We expect the current cyclical upswing to continue into 2017, as ongoing economic improvement is bolstered by proactive fiscal policies
- The environment remains littered with political pitfalls that are almost certain to generate volatility next year.
- As the “low volatility” bubble unwinds, bottom-up stockpickers1 will see a larger array of opportunities emerge
2016 was a challenging year for global investors, characterised by a high degree of macroeconomic and political uncertainty.
Markets shrugged off political uncertainty
In the first half of the year, concern about the pace of global growth and ongoing, aggressive monetary stimulus combined to drive continued outperformance of the so-called “bond proxies”2. Utilities, telcos and REITS were the best-performing sectors in the S&P500.
From June onwards, politics began to dominate investor attention, with Brexit, the US election, and the forthcoming European elections impacting market sentiment.
Despite the unfavourable backdrop, global equity markets delivered reasonable returns. As at the end of November the MSCI ACWI index had risen around 6% in US dollar terms.
A key driver of that return has been the gradual, yet undeniable, improvement in underlying economic indicators:
- Recovery in the US economy has been ongoing, with employment and housing data remaining robust.
- Monetary easing seems, slowly, to be having a positive impact in Europe.
- Stimulatory policies in China have clearly contributed to a recovery in commodity and energy prices.
Out-of-favour sectors in cyclical areas3 – materials, energy, industrials, but also financial stocks – have outperformed wider indices in recent months as investors have begun to recognise that economic fundamentals may not be so bad.
All in all, there has been a shift in investor sentiment since the middle of the year from one of caution, to one of cautious optimism.
Cyclical improvement to continue
The global cyclical upswing looks set to run further into 2017, supported by pro-active fiscal policies from the new US president. Donald Trump’s aggressive infrastructure and tax cutting agenda may yet be watered down in Congress, but we consider it highly likely that much of it will make it through, with material implications for US growth and earnings.
The current momentum in the US economy, boosted by the proposed Trump agenda, could deliver double-digit earnings growth in both 2017 and 2018.
A $600 billion infrastructure package could add around 0.25% to US growth, while a cut in the corporate tax rate from 35% to 15% could add 10% to US earnings growth for 2018.
Given that US earnings per share4 have not grown for three consecutive years, the current momentum in the economy, boosted by the proposed Trump agenda, could deliver double-digit earnings growth in both 2017 and 2018. That would be supportive of further gains in US equities.
The caveats, apart from a failure by Trump to follow through on his promises to revive growth, are numerous and mostly familiar.
Global debt, largely due to central bank policies, has continued to rise at an alarming rate. Very low financing rates have propped up capacity growth in a raft of industries, and the unwinding of excess capacity could still have a long way to go.
Bond yields, currently very depressed by central bank asset purchases, are now far less reliable than usual as indicators of growth and inflation dynamics. The recent rise in bond yields should therefore largely be seen as a normalisation, and not necessarily a sign of a dramatically different growth outlook.
Valuations globally remain unappealing, with most major markets trading above 10-year averages on earnings (the one clear exception being Japan). As interest rates begin to rise, it is likely that valuations will begin to compress: the US looks somewhat vulnerable in that respect.
We view the unwinding of the low volatility bubble as likely to provide a number of opportunities to add to some very good companies.
In contrast, Japan’s continuation of quantitative easing is likely to weaken the yen, boosting inflation and the competitiveness of Japanese industry. Equities here continue to look good value against bonds and could do very well in local currency terms.
Politics remain a major risk for global equity markets in 2017. European politics will again be the focal point for investors over the coming months. Forthcoming elections in France, the Netherlands and Germany will be defining moments over the political leadership and the future of the eurozone.
These elections will almost certainly cause swings in sentiment as we approach polling days. An unlikely but possible victory for the National Front in France would represent a major interruption for eurozone financial markets. Victory for the establishment parties in these countries will probably allow eurozone equities to climb a significant wall of worry, but any misstep could result in major disruption to bond and equity markets, not just in Europe but on a global basis.
Politics are also likely to materially impact emerging market returns in 2017, albeit for very varied reasons. Latin American returns will be meaningfully impacted by Trump’s approach to protectionism, and to immigration. In China, policy measures are resulting in a restructuring of unproductive industries and a gradual re-balancing of the very large stock of debt. The outcome of these measures is uncertain. In India, politics have again detracted from a solid economic backdrop.
Overall for emerging markets, politics and rising US rates could be a headwind, but fundamentals are broadly solid or improving. Real (inflation adjusted) rates are already much higher than in the developed world, and higher than they were at the time of the 2013 “taper tantrum”5.
Thriving on change
In such a transitory phase for global equity markets, we believe industries that can prosper amid regime change will thrive. The continued growth and disruption offered by select internet platforms and technology enablers should not only help defend margins through bouts of uncertainty, but these companies could improve market penetration.
The outlook is improving for banks meanwhile, with widespread cost cutting starting to pay off as regulators stop imposing capital and compliance costs. A better revenue environment is also emerging as nominal growth improves and rates move off their historic lows.
Ultimately, given that our approach is firmly “bottom-up” we view the unwinding of the low volatility bubble as likely to provide a number of opportunities to add to some very good companies across a range of sectors. It is likely that our portfolios will be more cyclical than in the recent past. However, given the uncertainties outlined above, a balanced approach from both a geographical and sector perspective would seem appropriate.
1. Bottom up investing is based on analysis of individual companies, whereby that company's history, management, and potential are considered more important than general market or sector trends (as opposed to top down investing).↩
2. Sectors and stocks perceived to be safe havens, with lower earnings volatility and higher than average dividend yields.↩
3. Movements in cyclical stocks tend to be more closely tied to the economic cycle, usually performing best when growth is strong.↩
4. The profits of a company attributed to each share, calculated by dividing profits after tax by the number of shares.↩
5. “Taper tantrum” refers to a surge in bond yields in 2013, which came as a response to the then-Federal Reserve Chair Ben Bernanke suggesting a tapering of quantitative easing↩
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