As always, predicting the direction of stock markets is a tricky business. Consensus thus far, and as of mid-December 2016, is indicating a slightly bearish view in 2017, which means that the chance of a bull market for equities cannot be ruled out.
There are a number of known events that could increase volatility in 2017 and as the possibility of them occurring increases, the more likely it is to be priced in to the respective market.
These include continued political tensions in Europe and the Middle East as well as a rise in populism and protectionism. Furthermore, given that at the start of 2016 there was very little probability of a Brexit vote or Donald Trump being elected, some more extreme low probability events that can’t be ruled out in 2017 might be a faster pace of US interest rate hikes, an oil price rise increasing the strength of expected inflation and the possibility that the UK court hearing over Brexit could lead to a general election and throw the UK leaving Europe into doubt.
We believe sector selection will be a key aspect to outperforming in 2017, as sector rotation has become an important factor towards the end of 2016. Sectors that we like include healthcare, financials, technology and consumer discretionary.
Home sweet home?
We suspect that UK growth in 2017 will be hampered by the uncertainty surrounding Brexit negotiations with market noise creating market volatility and capital flows. The Brexit situation has meant corporations both domestic, and those that reside overseas with UK operations, have been deferring investment in UK plc, which will likely put pressure on the jobs market and wage growth ahead.
Our biggest concern facing Brexit negotiations in 2017 is the potential for a significant change to the political landscape in Europe as Germany, France, the Netherlands and potentially Italy hold elections.
Weaker sterling could see overseas predators chasing acquisitions, pushing M&A activity up in 2017. Sterling remaining around the 1.20 – 1.30 mark and Brexit noise could prove a buying opportunity for UK investors to add home-grown companies to their portfolios in anticipation of the economy’s growth outlook improving in 2018.
The global picture
Whilst valuations in Europe look appealing, the elections in the region stated previously could provide headwinds, particularly as Euro-sceptic parties continue to gain ground. Across the pond, the likeliness that the US will be returning to more normal market conditions in 2017 is promising but that is of course dependent on the details of Donald Trump’s economic plans, combined with the speed in which they can be implemented.
In China, economic growth continues to be supported by stimulus but capital outflows and the sharp rise in its debt to GDP could hinder confidence. All the while, Japanese valuations look very compelling and a US FED rate hike(s) in 2017 should support a weaker Yen. Investors should appreciate however, that structural reforms and monetary expansion could prove a challenge.
2017 could indeed be a turning point for the Brazilian economy, as commodity prices seem to have stabilised, coupled with the expectation that political and policy uncertainty is waning. Moreover, Russia has been in recession for two years but 2017 could see its economy turn a corner supported by a higher oil price, a low interest rate environment and higher real wages.
India has seen a considerable amount of foreign investment inflows in the last fiscal year, overtaking China, to support energy and infrastructure projects. It is a promising growth economy that we suspect will continue to make positive steps in 2017.
Oil, Gold and Commodities
Thanks to OPEC and some non-OPEC producers agreeing to trim supply, the oil price has risen and held firmly above $55 per barrel recently. The rise in the oil price is a key component to inflationary pressure rising in 2016. At its current price level US shale producers are likely to be encouraged to increase their supply, which could kill the rally in the oil price. However, a number of factors could see the price rise or fall, not least OPEC or other parties not fully implementing agreed cuts to supply or a ramping up of tensions in the Middle East.
Gold experts have a range of views of where the price of gold might be over the medium term. What we can be certain of is in times of market uncertainty gold tends to fair relatively well. We also know that gold fairs well when the US dollar weakens. Investors should appreciate that gold is a good hedge against inflation, it’s held its pricing power against other asset classes in deflationary environments, and it tends to react positively when emerging economies are growing.
Commodity analysts are bullish on prices in 2017 after some years of oversupply are now returning to more satisfactory levels. Inflationary pressures and rising rates should be supportive ahead and a significant boost to fiscal spending in the US could see prices push higher. However, with global growth likely to remain very moderate there are likely to be limitations to the upside potential, which could also be hindered by a rise in political tensions and trade wars.
Investor insight
At The Share Centre, we maintain a preference for equity investing over fixed income in 2017, believing that the global economy will continue to grow, albeit at a very moderate pace. This pace we believe will continue to be dictated by the enormous pile of debt that still remains and is growing in the global financial system, limited policy options. However, those investors that need or want exposure to fixed income we have a preference for high yielding assets.
As noted, predicting the direction of the markets can be binary and unpredictable and ultimately leads to a strong argument for remaining invested and well diversified! With regards to equities, we have a value regional bias for Japan and Europe and from a growth standpoint we like the US and India.
From a sector perspective, we believe technology should be a significant benefactor from relatively higher margins over other sectors, financials in the US should benefit from a rising rate environment whilst consumer discretionary companies should benefit if wage growth is supportive. The US election was a headwind for the healthcare sector but the assumptions and risk highlighted in the election seem now to be fading and ahead less regulation could support its earnings outlook.
With borrowing costs looking set to rise, more defensive sectors such as utilities and consumer staples may lag. Ultimately, cyclicals should outperform defensives in a rising rate environment. However, accommodative monetary policy will remain present in a number of developed markets and so investors should judge their portfolio construction based on the factors that are present in the market they are seeking exposure to.
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