What I’m Watching For In 2017

Summary:

  • Trump’s presidency
  • Federal Reserve rate decisions
  • Brexit, hard or soft?
  • European Politics, France and Germany’s elections
  • War. West, east, religion, politics.

trump1

Trump policy

Education, Education… Education? Well, not quite. For Trump it’s all about infrastructure. In the build-up and immediately post Trump’s inauguration in January I expect there will be continued emphasis on infrastructure spending and putting America first. The important word here is ‘emphasis’. There are no clear outlines of infrastructure spending, no overriding approval from congress allowing higher government spending to fund such projects, and we’re unsure whether Trump has toned down from his pre-Election rhetoric – or whether he’s going to cause some deep geopolitical earthquakes.

Irrespective, the markets only need Trump to mention some forms of infrastructure economic stimulus and they’ll jump at it. This is because infrastructure spending boosts economic growth, improves productivity and stokes inflation, allowing companies to raise their profit margins and achieve the golden ticket of capitalism – maximisation of their share price. For example higher inflation from greater government spending leads to higher interest rates, allowing banks to increase their loan rates, and thus their profitability.

The worry with Trump, excluding social concerns, is trade. I’m still not quite sure whether Trump is going to be completely dedicated to protectionist policies, or whether it’s all hot air. Put one-way: Toyota’s CEO is not going to close his Mexican car manufacturing plant… over a tweet. However higher tariffs and a breakdown of free trade would surely damage vast areas of the U.S. economy, such as technology, which relies on the ability to sell innovative new products to a global audience.

Market response:
Cyclical U.S. equities to rise through 2017 and into 2018. These include industrials, financials, consumer discretionary and materials. Defensive equities, such as consumer staples and healthcare will suffer as investors move away from the bond-proxies.

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Federal Reserve

On the 14th of December 2016 the Federal reserve raised interests 0.25% to the 0.5-0.75% band. Not much of a change, and certainly nothing to burst the credit bubble. But significant. The message of this rate hike is that the economy is in good shape. Unemployment floats around 5%, and 150K jobs are added on average every month. This means over the period of a year a population the size of Birmingham succeed in joining the capitalist carousel. Wait, I mean job market. GDP figures in Q3 came in strong at over 2%, whilst wage growth is robust at +2.9% – the highest rate since the financial crisis.

Why did the Fed increase rates, and why is it important? The Fed has to raise rates when the economy gets stronger in order to help cool it down. Higher interest rates mean higher loan costs, which reduces consumer spending on items such as cars, houses, large items purchases etc. A higher rate also increases the discount rate, meaning money is more valuable today and therefore reduces the valuation of assets – such as stocks – bringing down the markets. The end goal is for higher interest rates to lower inflation, and with strong employment figures and solid wage growth, inflation is likely to start blooming its petals in 2017.

I’m a firm believer of higher interest rates, so this move is good. I’d like to see more than the 3 rate rises the Fed promised for next year. But this will depend on Trump’s economic policy and whether the U.S. economy stays on track. It will also be linked to global growth, because significant amounts of emerging market debt are priced in dollars, as well as commodities, therefore higher interest rates leading to a stronger dollar will put pressure on EM economies.

Market response:
Yield curve continue to steepen as interest rates seen to rise over the next 5 years. Emerging market funds will perform worse than U.S. funds.

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Brexit negotiations

Theresa May has come out this January with hints that she is willing prioritise immigration curbs over a fully-fledged trade deal. If right, and she ends up conceding on trade for that exact reason, this means we’re in for a hard Brexit.

What is a hard Brexit? It is the scenario where Britain comes out of the Brexit negotiations without a single market trading agreement. The media label it ‘hard’ because the economic fallout is likely to be more severe than if we remained in the single market. This is because we do not currently have comprehensive free trading deals outside of European, and therefore nothing to fall back on, furthermore roughly 50% of our exports go to the EU, with items such as cars and engines crossing the border multiple times as part of the manufacturing process.

Imagine a plane engine that requires UK engineering, but German craftsmanship. The engine may start its life in the UK, then float over to Germany to be tinkered with, sent back to the UK for an additional section, then back to Germany, before going back to the UK for the final touches and the Rolls Royce brand stamping, to then be flown to Dubai to be fitted in an Airbus. You can therefore see why our economy would be in danger if there were a tariff each time the engine crossed the border. Germany also benefits from free flowing trade in this process, however we cannot guarantee that EU nations will enter the negotiations with economic rationale. The EU is, after all, a social project.

Market response:
Every time a hard Brexit is suggested the pound falls -1%+. We can therefore expect further weakening of the pound. UK equity may not perform as strongly. However I’m confident that over the long term we will be able to secure agreements with other countries (China, Canada, India, America etc.) that will keep us competitive. Therefore dips over the coming year may present buying opportunities.

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European Politics

Matteo Renzi, Marine Le Pen, Angela Merkel. Three European names that signal a rocky twelve months ahead.

Matteo Renzi lost a constitutional referendum in December with the aim to reform parts of the Italian Parliament’s powers. Seen as a right wing populist vote, the no camp won leading to the resignation of Renzi and the near collapse of the world’s oldest bank Banca Monte dei Paschi di Siena.

Marine Le Pen is the Donald Trump of France. She poses anti-immigration, right-wing, populist challenge to the liberal ruling government. Her position is garnering support and she’s likely to make it through the first rounds of elections. The Presidential vote itself will take place on 23 April 2017.

Angela Merkel is up for some tough election herself. Germany will be holding its Federal Election to vote in new Bundestag members on the 22 October 2017 – by the latest. Merkel’s party Union party hold a majority of 11 at the moment, but the party is held together as a coalition and therefore Merkel does not have an official majority. Being a centre-right candidate, and the epitome of ‘liberal elite’, Merkel will have to fight off the populist movements.

Following Brexit last year it is clear 2017 will also be a test of European liberal values and whether the momentum of populist politics will carry over seas.

Market response:
Knee-jerk reaction is that there are clearer opportunities in U.S.A than in Europe. However even if worst case Marine Le Pen and German populism, it is worth noting that the FTSE is up 10% and near all time highs following Brexit, and the American markets are doing well post-Trump. The rhetoric may be that anti-establishment politics is harmful to the economy, but we have yet to see it materialize.

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War

My international relations credentials are patchy but, in my view, at no point since the cold war have we been closer to war than we are now. Tensions between east and west have amplified, with Russia pushing into Europe, hacking the U.S. election and also backing Syrian government forces, against the wishes of the UN who back the rebels. Civilian planes have been shot down over Ukraine, and Russia continues to violate air and sea space. Britain, on some accounts, will leave the safety of the EU, an institution stemmed in aid of preventing the reproduction of the atrocities of WWII. On top of this China continues to aggressively build military islands in the South China Sea.

The world has, over the past few decades, slowly become the Australia of 1800 – a place where peaceful existence occurs between species. The cynic in me says one-day a rabbit might turn up. Not necessarily 2017.

Market response:
Wars aren’t good for the markets.

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