It’s Not the Years, It’s the Mileage
Forecasting in 2016 was a tough business to be in given the wild year politically, the meaningful jump in interest rates - and rising geopolitical uncertainty broadly. It is hard to imagine the U.K. decision to leave the European Union or the U.S. election outcome making the world a more predictable place, yet each of these outcomes was met with either momentary indifference or sustained optimism by global stock markets, seemingly disproving the old Wall Street adage that “markets abhor uncertainty”.
This year looks poised to be just as unpredictable as the last on the political front as the Trump administration takes shape, Brexit talks commence, and national elections in the European Union’s two largest economies come into focus. As a result, 2017 looks to be a year where investment returns will disproportionately rely on political outcomes globally. As such, we are highly attuned to a number of important political issues in the coming year, most notably:
United States: Given the markets have responded with the strongest post-election market rotation in history, the most impactful storyline in the coming year will likely be our own. In the first half of 2017 it will become clear how serious President Trump is about infrastructure spending and how serious the Republican Congress is about fiscal discipline. If a corporate tax cut, the repatriation of international profits, infrastructure spending and a less onerous regulation landscape unfolds, markets will continue to be supported by this new political regime. Conversely, if the campaign’s protectionist campaign rhetoric results in an elevated possibility of a Chinese trade war, or our foreign policy becomes less predictable, markets will come under acute pressure. Presently, the markets are anticipating a ‘softening’ of the campaign rhetoric but we suspect the “truth will lie in the middle”, with a combination of the good and the bad in the coming year. This will likely create market volatility over time.
United Kingdom: In Britain, investors have discounted a “hard” Brexit, in which the UK forgoes its single market access in exchange for control over its borders. A “soft” Brexit, where the UK maintains current single market access for goods and labor with the European Union, would be a positive surprise — although unlikely given Prime Minister Theresa May’s perceived mandate. Meanwhile, the British Pound has shed nearly 30% of its value over the last 2 years, which should encourage tourism and exports, potentially softening the likely recession that is now pending for Britain. We anticipate a tough road ahead for the country, a weaker currency and growing inflationary pressures as they work towards an eventual Brexit by 2019.
Europe: Meanwhile on the Continent, the voters will be the central policy makers. French and German elections this year will either be uneventful and therefore positive surprises to the markets — or potentially highly disruptive. While unlikely, it is possible in this political climate that Marine Le Pen will win the French presidential election in early May. Her candidacy is centered on introducing a referendum on French membership in the European Union. The economic consequences of a “Frexit” would make the Brexit look like a local city council election as the European Union would likely fail without France as a member. In Germany, Angela Merkel’s ability to keep her job is looking less assured. Without her leadership, there would be a major void at a time when strong leadership is badly needed. We will be monitoring both elections closely in 2017.
Oil: The politics of oil will play a big role in market outcomes over the coming year. Supply from the biggest oil producers, particularly Saudi Arabia and Russia, is now in focus following the OPEC deal to cut output for the first time since the financial crisis. OPEC compliance with the deal will determine when supply and demand ultimately come into balance and whether prices remain above $50 a barrel. We consider this first supply cut deal in almost a decade to be very significant — and believe it marks a supportive change in the price of this commodity.
The Federal Reserve: While the Federal Reserve is designed to be an ‘apolitical’ body, its policy choices will certainly have an impact on market outcomes in 2017. Investors currently foresee a pro-growth Federal Reserve under Janet Yellen and expect three rate increases in 2017. If the Fed moves too quickly, the repercussions could be severe as six of the twelve tightening cycles since 1945 have resulted in a US recession occurring within two years. Rising long term bond yields should help banks and other financial institutions boost their net interest margin — the difference between rates on their borrowing and lending. In addition, regulatory intensity is also likely to diminish with the possible redrafting of the Dodd-Frank Act and the softening of restrictions that have been in place since the financial crisis. We do not anticipate a ‘too fast’ outcome for interest rates in 2017 and see a positive backdrop for the banking industry and the U.S. economy from these ongoing policy conditions.
Emerging Markets: In China, the National Congress of the Communist Party meeting (held every five years) begins in November. Until then the party will likely do whatever it can to avoid any potentially disruptive events economically or otherwise. That said, U.S.-China saber rattling on trade and territory — plus a strengthening U.S. dollar and higher bond yields — will act as a headwind to emerging stock market returns while tightening oil markets will likely act as a tailwind for many of the oil exporting countries in this group. This push-pull dynamic will add to overall global uncertainty in the year to come. And yet, given the market adjustments over the last five years, we see emerging markets offering long-term potential opportunity at this time.
Such are the recognizable political inflection points as we enter the ninth year of the worldwide economic recovery this summer. We suspect the political machinations around the world will play an important role as we enter the mature stage of our economic recovery. While the future is unwritten, perhaps our best prediction for 2017 is captured by the Wall Street chestnut “buy the rumor, sell the news”, or adjusted for this moment’s parlance, “buy the vote, sell the policy” in the coming year. Optimism tends to fade as the possibility for disappointment relative to expectations increases.
As such, now is not the time for investors to put all their eggs in one basket, or bet on just one asset class, despite a strong showing in stocks at the expense of bonds in the recent period. Rather than make significant portfolio changes in response to these worldwide political events, we believe that it is prudent to maintain a commitment to your long-term, highly-diversified portfolio allocations that are tailored to your long-term financial plan — and to be flexible to the substantive policy changes likely to unfold in the years ahead.
This information has been developed internally and/or obtained from sources that Sand Hill Global Advisors, LLC (“SHGA”), believes to be reliable; however, SHGA does not guarantee the accuracy, adequacy or completeness of such information nor do we guarantee the appropriateness of any investment approach or security referred to for any particular investor. This material is provided for informational purposes only and is not advice or a recommendation for the purchase or sale of any security. This information reflects subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. This material reflects the opinion of SHGA on the date made and is subject to change at any time without notice. SHGA has no obligation to update this material. We do not suggest that any strategy described herein is applicable to every client of or portfolio managed by SHGA. In preparing this material, SHGA has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision, you should consider, with or without the assistance of a professional advisor, whether the information provided in this material is appropriate in light of your particular investment needs, objectives and financial circumstances. Transactions in securities give rise to substantial risk and are not suitable for all investors. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.