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December 20, 2016

2017 outlook

Since our comments on the implications of Donald Trumps election win have garnered so much interest, we wanted to follow-up with our outlook on 2017. Here we discuss in more detail the key changes we expect for this year. In summary, we believe that we have reached the end of a period that has been characterized by excessive central bank accommodation, financial repression, low growth, low inflation and low yields. The 10 key points what this means for the investment landscape in 2017 and beyond:

  1. The governments in the US, UK, Canada and Japan (less so in Europe) are moving away from austerity and towards expansionary fiscal policy.
  2. Monetary policy has reached its limits. We are now seeing monetary policy as the key policy lever following the financial crisis being de-emphasized. As the fiscal stimulus hits an economy that is running close to full-employment, we expect the inflation rate to pick up, thus leading to rising Fed fund rates.
  3. Populism is gaining ground. Not just in the US and UK but also other parts of Europe. At its core, populism means less globalization, i.e. less immigration and less free trade. Welcome to Trumptopia.
  4. The combination of the above, i.e. stricter monetary policy, more stimulative fiscal policy and more populism could well herald the end of the 30 year bull market in bonds. We expect long-term interest rates to continue moving higher.
  5. The economic cycle (especially in the US) will be stronger but shorter. We expect a combination of faster growth in the short-term with a higher probability of a recession after 2018. Faster economic growth will lead to an acceleration of inflation. The Fed is likely to slam on the brakes sooner than otherwise to tame rising prices, thus triggering a downturn in the economic cycle. But this is not the story for 2017.
  6. In equities, the winners of the last cycle are unlikely to be the winner of the next cycle. In the last few years, dividend stocks and other bond proxies have outperformed. There was a scarcity of growth and of income and they fit the bill perfectly. However, they now trade at lofty valuations and as the US economy picks up steam, growth is no longer at a premium. In the balance of this recovery, we suspect leadership will shift towards smaller companies, industrial/capital goods stocks and financials. Investors should consider the factor and sector bets embedded in their equity portfolios
  7. In credit, rising interest rates will put pressure on valuation but we continue to see a very benign default cycle during 2017.
  8. The US Dollar will continue to be strong versus most other currencies. Expansionary fiscal policy and tighter monetary policy are a textbook case for a rising currency.
  9. Emerging market assets are cheap (especially equities) relative to developed market assets, but historically a rising US Dollar made for a difficult environment for EM. However, a bigger risk than FX are trade policies. Risks to EM assets have undoubtedly increased since the US election. While Trump has toned down many of his campaign pledges, his strident comments towards China following his election point to a significant policy shift vis-à-vis the largest EM economy. China is not operating from a position of relative strength given its large trade surplus and an excessively indebted economy.
  10. Will the last optimist for Europe please turn off the lights?  Yes, Europe will continue to struggle in the absence of a coordinated plan to boost the economy and centrifugal forces will get stronger. But this is well known. What is maybe overlooked is the fact that the Euro zone is in the middle of a cyclical upswing. Euro zone acceleration in 2017 is still a pretty out of consensus idea! While the doom-and-gloom headlines about Europe dominate, most people don’t realize that at the end of 2016, the Eurozone reported the lowest unemployment rate in 7 years! We shouldn’t also forget that the EU has a trade surplus with the US and will benefit from a strengthening US recovery. In addition, EU equity indices have a much bigger weighting in financials, materials, industrials and smaller weighting in technology – in a rising rate environment, the former could outperform. 2017 is the wrong year to get all negative about Europe in our view.


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