Trump’s controversial first few weeks in office and Brexit developments have been the main focus for the new year.
Donald Trump’s first few weeks in office have been the main focus for markets at start of 2017. The post-election exuberance has lost a little momentum but markets appear to still be giving the expected Trump economic boost the benefit of the doubt. Closer to home, Brexit is back on the radar for markets with the government likely to trigger Article 50 and officially begin divorce proceedings with the European Union (EU) in the coming months. The improving economic backdrop in the Eurozone has proven a welcome distraction for what’s likely to be a challenging political period for the region in the first half of 2017. Politics are likely to remain a key focus for markets globally in the near-term. Given the potential for further twists and turns, we expect market volatility to pick up from the current low levels.
As expected the start of Trump’s Presidency has not been without controversy, but the real focus for markets is on the scale and timing of his proposed fiscal stimulus measures, aimed at boosting the US economy. Early signs have been encouraging with Trump quickly signing off on a two high profile infrastructure projects in the energy sector. But given that markets have already priced in the prospect of higher growth and inflation, and US equity market valuations have moved back to elevated levels; there is scope for disappointment if the overall scale of the fiscal stimulus underwhelms. Possibly the greatest risk is that the tax cuts do not get signed off by congress until the latter end of the year meaning they won’t impact the economy until 2018. In the meantime, tighter financial conditions (a stronger dollar and higher interest rates) could act as a drag on the US economy going into the second quarter of the year. We remain cautiously optimistic that Trump can deliver policies that will lead to higher growth. However, unless we see details of his plans soon, markets could rapidly begin to lose patience.
The economic landscape in the Eurozone has continued to look brighter in recent months. GDP growth picked up to 1.8% in 2016 and more forward-looking indicators (such as Purchasing Managers’ Indices and consumer confidence surveys) are pointing to a further pick-up in activity in this year. Indeed analysts have begun to upgrade their earnings forecasts for this year in response. An improving economic climate, combined with relatively attractive equity valuations and abundance of internationally-focused companies, means we are warming to the Eurozone market. However, the region also faces a potentially disruptive election timetable including key elections in the Netherlands (March) and France (May). The latter will be of particular interest for markets if the polls show the anti-Euro Marine Le Pen is gaining traction. While we acknowledge the increasingly unpredictable nature of the political landscape, we have started the process of gradually increasing our exposure to European equities.
In the UK, Brexit has very much been the focus at the start of the New Year. Theresa May has outlined her strategy with the government seeking a clean break from the EU as she pledged the UK would quit the single market. She has won the support of MPs in the commons and the government now looks on course to officially trigger Article 50 before the end of March. The UK government goes into Brexit negotiations with the economy on a firmer footing. The first estimate of Q4 GDP came in marginally above expectation at 0.6%, meaning growth in 2016 of 2.2%. 2017 consensus forecasts have ticked higher but growth is still expected to come in at just 1.2%. Inflationary pressures have continued to build in the UK as a result of the weaker sterling driving up the price of imports. Inflation is expected to rise to around 2.5% this year and market interest rate expectations have crept higher in recent months. However, we continue to believe the Bank of England will look through the nearterm spike in inflation for the time being and keep interest rates low. Particularly with inflation likely to outpace the growth in wages, eroding disposable incomes and acting as a headwind for UK consumption in 2017.
Having been one of the main (and surprise) beneficiaries of Trump’s election victory, Japanese equities have lost momentum at the start of the year. The equity market has a strong negative correlation with the yen (as the yen weakens, the market generally moves higher) and Japanese stocks have suffered from the yen strengthening against the dollar. Although we remain generally positive on the Japanese market, the currency plays a significant role in direction of the market. As a result, much will depend on the dollar strengthening against the yen once again from here.