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What does 2017 have in store for global investors?

What does 2017 have in store for global investors?

By Rick Lacaille
Friday 9th December 2016

For global investors, 2017 is shaping up to be another year where top down global, political and policy developments will have an outsized impact on investment returns.  Seismic geopolitical events marked 2016 as a game-changer across the global political landscape, with significant implications for economies and markets. These shifting forces create an environment in which investors may need to align their strategy to ever-more nuanced return and yield opportunities, and revisit their defensive strategies for uncertain times ahead.

The resonance of Donald Trump’s protectionist message and the UK’s Brexit vote are perhaps the most explicit examples of a reversal in the post-war trend toward globalization as uneven gains from trade become an incendiary political issue in many countries.  Meanwhile, with monetary policy perhaps at its limits, fiscal policy is likely to come into greater focus in 2017 as the preferred policy lever of governments to prop up subdued global growth, setting up a very different potential opportunity set for investors.

Protectionism on the rise

Proposed global trading agreements are losing support; the 12-nation Trans Pacific Partnership (TPP) is opposed by the incoming Trump administration and seemed unlikely to get through the US House of Representatives under either election outcome, while a trade deal between the EU and Canada that was seven years in the making almost collapsed in October. Hard data points to global trade and capital flows holding back global growth; imports have fallen as a share of GDP for four consecutive years for the twenty largest economies[1]. Moreover, the number of protectionist trade measures imposed globally in 2016 is five times as many as through the same period last year[2].

A broad reversal in global trade is almost certainly a negative for global growth and is consistent with our modest return forecasts for global equities.  For S&P 500 companies, 30% of revenues are derived from overseas operations[3], so limitations to growth in foreign markets will make it difficult to reverse the mostly negative trend in earnings over the last two years.  Within certain local industries, however, protection will be beneficial as firms become more competitive domestically, just as it will be a drag on companies with substantial overseas exposure.

 Policy shift: game-changer for investors?

As 2017 unfolds, the central role monetary policy has played to support markets and suppress yields will again be evident. Both the ECB and BoJ have acknowledged that low and negative rates impair savers and ECB officials recognize their adverse impact on lending and bank profits[4].  However, with inflation well below target, the odds are still good that some further monetary policy easing is on tap in the eurozone and Japan in 2017. The question arises though: what additional tools, if any, are available to global central bankers if what has already been tried no longer works?

One risk to investors is a possible reversal of the ‘lower for longer’ thematic that has supported bonds and bond-like proxies in the global search for yield.  For a taste of what that could look like if expectations are not managed well, an expected ECB announcement on extending its asset purchase program that failed to materialize in September was quickly followed by higher US and German 10-year rates and falls in high yielding equities and REITS and, to a lesser degree, growth assets generally. This dynamic repeated itself immediately following the US election as bond yields surged on expectations that unified Republican control of government sets the stage for deficit-financed tax cuts and infrastructure spending.

Fiscal policy focus

As the wisdom of ultra-loose monetary policy support is being questioned, the discussion has shifted to the worth of government approaches such as those involving taxing, spending, and in all likelihood, a touch of borrowing for good measure. Canada has announced a substantial infrastructure-focused fiscal stimulus package worth CAD$120 billion over 10 years, while Japan and China are among others to ramp up fiscal measures.  Even the International Monetary Fund (IMF) has endorsed increased government spending, recently stating that fiscal support “remains essential for generating momentum and avoiding a lasting downshift in medium-term inflation expectations.”[5]

In the United States, the election of Donald Trump brought pledges of additional infrastructure spending of up to $1trn[6]   UK policymakers appear to be targeting infrastructure and housing investment to subdue any economic turmoil related to Brexit.  And while eurozone nations are nominally restricted as to their levels of deficit spending, additional leeway to countries such as Spain and Portugal has been allowed.[7]  So fiscal policy seems to be the wave of the near-future, but how much faith should investors put in the governments purse and what areas of the market is it likely to impact?

Investment impact

There are a number of angles from which a pivot towards fiscal policy could impact investors’ portfolios.  In this case, infrastructure projects appear overwhelmingly favoured and heavy equipment manufacturers and materials companies should benefit.  But be wary, as fiscal policy works over longer periods and unlike monetary policy, with its monthly and quarterly pronouncements, it may not hold the same level of investor attention as funds are disbursed in fits and starts.

To the extent sizable fiscal programs are crafted into legislation, that would likely lead to upward pressure on borrowing costs, though from a very low base.  And even if the bond market vigilantes have been tamed or frustrated by central bankers, currency markets would have no problem imposing some degree of discipline on profligate spenders.  Look no further than the value of the British pound for evidence.

Overall, we see 2017 as a year which will be continue to be punctuated by significant, and at times unpredictable, political and economic change. Investors will need to consider how best to position their portfolios for the opportunities and risks these bring.

Opportunities remain, but the evolving complexion of bond and equity markets demands a nuanced and cautious approach.But as the complexion of markets continues to evolve, we consider how yield in 2017 may be found in unexpected places, and where caution is warranted.

Rick Lacaille is CIO at State Street Global Advisors

[1] Wall Street Journal, October 6, 2016, “Worries Deepen That Globalization Is Hitting the Skids”

[2] Wall Street Journal, October 17, 2016, “Stock Prices Under Threat as Global Trade Becomes a Pariah”

[3] Factset

[4] Wall Street Journal, October 4, 2016, “ECB Officials Express Concerns Over Effect of Negative Interest Rates on Lending”

[5] International Monetary Fund World Economic Outlook, October 2016.

[6] http://graphics.wsj.com/elections/2016/donald-trump-hillary-clinton-on-the-economy/

[7] Wall Street Journal.  October 24, 2016.  “Fiscal Stimulus Wins More Fans.”

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