Henderson: 2017 outlook - two great unknowns

What lessons have you learned from 2016?

Even with perfect foresight into the results of 2016’s extraordinary political events, I suspect most investors would have been wrongly positioned to a greater or lesser extent for what subsequently transpired in markets. It is a salutary reminder of how tricky investing can be, and how frustrating – particularly as there is every chance that you may have peers or competitors who have thrived this year despite being entirely wrong about the year’s headline market-moving events. For sterling investors, the overriding boon was to have an entirely unhedged international portfolio.

On an asset class and regional level, currency movements dominated proceedings. The key has been to understand how those changes translated into current account balances, bond yields, and company earnings. Some developing markets deservedly re-rated, having taking painful currency adjustments, emerging on a firmer footing, while China stimulated and de-valued. Elsewhere, Europe muddled on and the US appeared to fix on a steady course until November’s presidential election delivered a shock.

What are the key themes likely to shape markets in 2017?

For all markets, the last eight years have been defined by the actions of central bankers. 2017 will likely be shaped by the reversal of some of those moves, or a marked diminution in activity. As this monetary tide continues to ebb, it remains to be seen whether the tapering of asset purchases – or outright monetary tightening – can be matched or offset by other factors.

Clearly, following Donald Trump’s election victory, many hopes are pinned on a huge fiscal stimulus in the world’s biggest economy. And, while it is hard to imagine Angela Merkel trying to bribe the German electorate with similarly grandiose promises, there is already a general fiscal easing across Europe in evidence. While not massive it is a very clear reversal of the austerity handbrake that was being applied to European gross domestic product. UK Chancellor Philip Hammond has so far been able to refrain from fiscal stimulus, given the apparent robustness of the post-referendum UK economy, but he has made it very plain that he is ready to act if activity falls away. Elsewhere, China is like a car without a brake pedal. If it loses too much speed it will push on the accelerator; if it worries about losing control it takes its foot off the pedal. Braking is not really an option (although crashing might be).

Despite all this potential fiscal action, I am not convinced of its impact on aggregate company earnings, especially as soon as 2017. We know that higher bond yields are bad for earnings multiples due to the nature of discounted cash-flow analysis (a higher discount rate equals lower net present value). Also, history shows us that when inflation expectations outpace growth expectations then multiples experience further pressure. Tax cuts would certainly give consumers and companies an immediate boost, but infrastructure benefits take years to come through. Meanwhile, most of Trump’s other vote-winning proclamations on protectionism will undoubtedly be a negative for growth. The supply chains of US manufacturers are so global in nature that tariffs would be hugely damaging to ‘US Inc’.

Which assets classes could benefit or struggle given this environment?

I think current emerging markets fears over protectionism are overdone. A stronger US dollar is a headwind for some countries with funding issues, but it is not a universal issue; many countries and companies in the emerging world are on a much more solid footing now and will benefit from stronger growth in the US and elsewhere.

The move higher in bond yields looks to have got close to running its course unless inflation pressures really take hold and central banks are judged to be behind the curve. This looks a remote possibility due to the structural problems across the developed world, particularly ageing demographics and levels of spare capacity in Europe. Trump appears inflationary, but unless he actually imposes widespread tariffs and deports a large proportion of his workforce, then inflation remains in check. Moreover, the US might be tightening but Japan and Europe are anchored at zero. On a relative basis, treasuries will continue to look attractive.

The main risks for 2017 once again focus on the European Union (its politics and its banks) and China (its property and credit bubbles). Our base case scenario is that both muddle through. If global growth is respectable and bond yields behave, then equities could move higher. It is unlikely to be a smooth trajectory though as investors confront two great unknowns: how to extract oneself from the biggest monetary experiment of all time and how much of Trump’s rhetoric actually becomes policy.