This year has started well for many investment markets, and builds on the strong finish to 2016.
Having said that, it’s likely the elevated global geopolitical volatility of 2016 will continue in 2017.
But, we do not expect this will derail the financial plans of long term investors.
What are the key geopolitical issues we face this year?
Firstly, the inauguration of Donald Trump as US President seems set to see an increase in tension between China and the US. The obvious flashpoints being China’s territorial claims over the South China Sea, trade and the US accusations of China manipulating its currency.
Secondly, following the UK’s unexpected Brexit referendum result, it is inching closer to exiting the European Union.
The poignancy of this unexpected outcome has further implications for Europe in 2017 with key members France, Germany and Holland all going to the polls this year. In France and Holland the popularity of Nationalist parties is such that they have a realistic chance of winning in these elections.
Regardless of whether they win or not, they will poll strongly, potentially increasing political instability within a more fragile European Union.
And, thirdly, the unconventional approach of Trump is itself a driver of volatility as the world begins to adjust to his US-centric, less diplomatic style of communication and leadership. This significant change makes it far more difficult to form a view of how the geopolitical landscape will change in the coming year and what impact it will have on markets.
So, how do we think key investment markets will fare in 2017?
We believe many of them will perform solidly, despite the likely global geopolitical volatility.
The Australian share market, much like the rest of the world, has had a good start to 2017. While no longer cheap, the market is supported by positive sentiment toward global growth and earnings expectations.
The significant recovery in commodity prices experienced in 2016 is not forecast to be repeated in 2017 however, we do expect commodity prices to be buoyed by global growth (particularly in China), which in turn will see support for our key materials stocks.
The Banks also will benefit from global growth as the Australian economy benefits generally.
Improving employment data indicates that employers are more positive toward 2017 and assuming the trend continues it will be supportive of the industrial and banking sectors.
A further fillip to our growth could come from stronger US growth, assuming President Trump is able to successfully stimulate the US economy as proposed. If Trump is not successful in rolling out his policies, there is a risk that growth could stall.
Other risks to Australian shares this year include the possibility of slower-than-expected growth in the economy and unexpected increases in interest rates negatively impacting on margins for the banks and sales revenue for industrial companies.
The US market
The US share market has flirted with its record highs a number of times already in 2017 as the Trump post-election rally continues. The markets are awaiting more clarity on Trump‘s plans and the likely timeline for the implementation of these stimulatory policies.
Given the US market is ‘expensive’ at current levels, earnings growth and confidence that economic growth will result from Trump’s polices is necessary if that rally is to extend beyond the February company reporting period.
The US economy has continued its recovery after the GFC; the unemployment rate is now at 4.7% and the second rise in interest rates made by the Federal Reserve (Fed) in December 2016 affirms the economy’s sustainability. The markets are increasingly pricing in that the next Fed rate rise will be in March 2017.
Should President-elect Trump increase infrastructure spending and/or decrease company tax rates as proposed, this could provide a strong tailwind for the US economy and corporate earnings.
However, the risk to this scenario is policy failure and potential for a rise in geopolitical and trade tensions, a real possibility given Trump’s strong US-centric position.
European share markets
European share markets remain relatively cheap when compared to their US counterpart. Following the Brexit vote and ongoing social and political instability within member countries, the overall risk in the region is considered high, hence the cheaper share markets.
We do not expect European markets to fall significantly, as share prices remain reasonably well supported by earnings. However, as Germany, France and Holland all go to the polls this year, markets could remain captive to the social and political events.
In addition, Great Britain is still coming to terms with how to actually exit from the European Union however, the significantly weaker pound is expected to help its economy and trading conditions into 2017.
After experiencing some turmoil in 2016, the capital outflows from emerging markets appear to have ceased, leaving markets at reasonable valuations.
If the sector can deliver on its growth objectives and global growth continues its path to recovery, then emerging markets can be expected to see positive results in 2017.
The increasing tension between the China and the US could be a destabilising force on emerging markets. President-elect Trump is actively reviewing a range of trade agreements the US has, key among these are with China and Mexico.
Longer term we remain positive toward the emerging markets but recognise they can be subject to bouts of high volatility, a situation exacerbated by investment capital flows in and out of the sector.
China, now the world’s second largest economy, has a targeted economic growth rate of 6.7% p.a. which augers well for investors. However, there are ongoing concerns over the level of Chinese corporate debt and how it will be managed.
Australian listed property (REITS)
After experiencing a 20% decline in the September quarter of 2016, the Australian listed property sector has recovered much of the lost ground and looks set for a period of reasonable growth in 2017.
Consolidation amongst some of the larger managers of property trusts could provide a boost to earnings via improved scale and along with improving economic growth is likely to be a tailwind for the sector in 2017.
Unexpected rises in interest rates would be a headwind for the sector because the favourable return differential property has over fixed interest assets, such as bonds, would be reduced.
Longer term, performance should be reasonable given the 2016 correction appears to be behind us. The property sector is currently backed by solid yields and leverage across the sector remains acceptable.
Australian fixed interest
Rapid rises in bond yields in the fourth quarter of 2016 have detracted from bond fund returns with bond prices falling as interest rates rose.
While the strength of the rise in interest rates was surprising, we are not forecasting rates to rise back to pre-GFC levels this year unless global growth rates decline unexpectedly.
Our base case is that interest rates will remain below their historical averages for quite some time. We expect rates will broadly respond to the level of global growth in the near term and that stronger-than-expected economic growth could translate to higher interest rates and after a long hiatus, higher inflation as well.
In the near term much hinges on US economic policies. Should Trump’s infrastructure program and reduction in the US corporate tax rate be implemented and have the desired effect, this should cause upward pressure on interest rates in the US and in other economies including Australia.
If the global economic growth rate falters, interest rates may respond accordingly by falling or at least stagnating.
Rising US rates could also result in a stronger $US. Should this occur it will be a positive for the Australian economy as a lower $A is beneficial to our key export sectors which include agriculture, education and tourism.
There has been a positive start to 2017 but for it to continue the world awaits the delivery of the policies proposed by US president-elect Trump as the key catalyst for a continuation of economic recovery.
Global markets have already priced in much of this policy delivery so a measured view of the future is the prudent course at this point in time.
There are many unknowns and economic variables to consider, but for the moment economies and investment markets appear to have a ‘glass half full’ character to them.
It could be a good year for investors.