It’s a new dawn a new day

A strong finish to 2016

2016 proved to be a year of surprises, particularly so on the political front with the election of Donald Trump and the outcome of the EU referendum. In spite of this, and some fairly widespread pessimism at the start of the year, including a well-publicised January call from RBS to ‘sell everything’, markets generally climbed a ‘wall of worry’, and a number concluded the year at all-time highs.

The election of Donald Trump has seemingly marked a sea change for markets on the expectation that his policies will drive faster economic growth, higher inflation and higher interest rates. In turn, this has driven a selloff in US Government bonds and pushed equities higher. Given the extent of the move there is the concern that markets, particularly in the US, have potentially got ahead of themselves, not least because he hasn’t even been inaugurated yet, and also that typically these are policies which cannot be undertaken immediately.

2017 – much to consider

We start 2017 with much to consider. On the political front elections are scheduled in a number of key European countries, including the Netherlands, France, Germany and potentially now Italy. The year will also be heavily influenced by decisions made last year, not least the election of Donald Trump and the UK’s decision to leave the European Union.

The UK looks set to have another year of Brexit dominated headlines, with Article 50 expected to be triggered by the end of March. The uncertainty of this alongside inflationary pressures, due to the fall in Sterling, as well as the rise in commodity prices, means that the outlook for the domestic economy is likely to be quite challenging, as real incomes come under pressure. That said, Sterling weakness and current EU market access remains a boon for exporters and the year starts with UK manufacturing in good health.

In contrast to last year, the global economy begins 2017 on a firmer footing, but also with a heightened level of political uncertainty. As such we suspect that the year ahead will see periods of volatility, particularly in Europe given the election calendar.

Government bond yields typically bottomed out over the summer, in the UK 10-year Gilt yields traded below 0.55% and finished the year around 1.3%. Whilst clearly more attractive than they were, they remain an unattractive proposition in the context of rising inflation, unless one is particularly nervous about the future.

The incredible rise of Donald Trump from an initial no hoper demonstrates that nothing should be taken for granted. Nevertheless, we suspect the economic backdrop coupled with changing Government policies will mean that the year ahead will likely favour equities over bonds, albeit careful stock and sector selection will be key. As was the case in 2016, M&A activity looks set to be an ongoing feature and in spite of the uncertainty of Brexit, continued overseas interest in UK companies in the face of a weak pound remains likely.

What have we been watching?

  • UK equity market finishes December at an all-time high
  • Markets respond positively to Trump’s pro-growth agenda, but will he live up to the hype?
  • US interest rates increase and the Fed signals 2 and possibly 3 more increases likely in 2017
  • Globally, it is not a question of how much the US increases interest rates, but rather how much the global economy can withstand
  • The unpredictability of a Trump presidency, increases risk
  • Global bonds trend higher but inflation edges up
  • In Europe, the ECB tapers monthly bond purchases but extends the programme until the end of 2017
  • In the UK, PM Theresa May signals the Brexit process will get underway in March 2017, but will the EU play ‘hardball’ given the key European elections?
  • The Italian cabinet approves a state-bailout for the country’s oldest and third largest bank, Monte dei Paschi di Siena.
  • OPEC and non-OPEC members agree oil production cuts, but will they be able to implement them successfully? Brent oil reaches $57.
  • Weak Sterling tempts more overseas buyers to buy strategic UK assets with a number of takeovers announced.

Summary

After a ‘Santa rally’ the UK equity market closed at an all-time high. However, a reflationary environment could be positive for many companies. The UK could also see more M&A activity in 2017. In the USA, Trump’s ‘America First’ policy with proposed corporate tax cuts and repatriation of US company cash trapped offshore suggests more M&A and share buy backs.

Despite the political risks in Europe, markets appear to be entering 2017 in a reasonably confident mood. The main risk in the short-term would be that markets have become too optimistic about Trump and he fails to deliver on many of his campaign promises.

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