As mentioned in last quarters commentary, Central Banks are pausing and reversing some of their policies, partly because they have limited ammo left in their tanks, but also because there is a changing inflation landscape and perhaps the ‘hope’ that some Fiscal policy will help take some of the strain. The US Fed, provided the final (small) surprise of the year by saying that they will likely increase rates 3 time next year, the market anticipated 2, with many analysts still believing that this will be the case.
The media and self-flagellation of economists continued in the UK, with many admitting that they are not soothsayers. The UK economy rose by 0.6% in Q3 and the latest data, points to growth of 0.5% in Q4. The Bank of England believe that following 2016 growth of 2.2%, we should expect 1.4% in 2017. It is worth remembering the amount of uncertain variables that go into these projections and why we should not be surprised if they get it wrong. Below are the current forecasts for inflation and GDP growth, with the darker colours indicating their expectations and the lighter colours, possible but not likely.
BOE Realised and Forecast CPI BOE Realised and Forecast GDP growth.
Source: Bank of England November 2016 Inflation Report
So we are to expect positive but lower growth of 1% to 2% over the next 3 years, certainly a recessionary environment is an outlier expectation.
Post the US Election, equity markets rallied into the New Year, shaking off any concerns about the foggy economic policy of the incoming US President, the machinations of the impending UK exit of the EU and the referendum result in Italy amongst others. Sterling has continued to fall, US$ powers higher, Euro is at 14 year lows vs US$, the Oil broke to 16 month highs (nearly doubling in a year) and Gold gave up most of its gains from the year.
Fixed Income markets however fared very differently in Q4. Expectations of higher inflation are not great for those holding cash and fixed interest assets, especially those with long durations.
Moving into 2017, the political/market risk continues with more elections for the French and Germans, EU/UK divorce proceedings and the reality of a Trump presidency.
One must remember that economic growth does not necessarily equal market growth over the short term. We still believe it is prudent to be in diversified, multi asset solutions, but prefer to be underweight/have no exposure to perceived ‘safe assets’ (commercial property, infrastructure et al) which have benefitted hugely from falling interest rates, QE and the impact of falling bond yields.
Can the more recent equity Bull market continue? We believe it can, perhaps not at the same growth rate and with the same leaders. There is potential that the strength of certain company stocks performance over recent years may decline relative to different industries and companies that will benefit from a different fiscal strategy.
Fixed Income: Given where we are in the economic/market cycle, we would expect Fixed Income to underperform other asset classes over the medium to long term.
Whilst central banks have continued to stimulate economies via reducing interest rates, quantitative easing and accommodative policies, we believe we are nearer the end of the cycle than to the start. The losses that would have been felt by investors in Q4 have potential to increase through the year.
Our view is that government bonds are expensive, but could get more expensive if global risks materialise. The global hunt for yield has led to certain sectors of the corporate bond market being expensive, but would prefer corporate bond vs government.
Equities: Despite expectation of increased volatility, we expect equities to outperform other asset classes over the medium to long term.
Earnings growth is a concern globally and we would like to see more if there is to be any more multiple expansion. Energy, Financials and US Mid/Smaller cos have bucked medium term trends and look set to continue.
We recommend a diversification approach across regions and market capitalisations and favour a ‘value style’ approach.
Property: Valuations are above average compared to history and appear full and would recommend an underweight position.
Alternatives: In the below average growth world with potential volatility in safer asset classes on the rise, absolute return vehicles are a viable option.
Gold has unique properties in the investment world, with its demand based on its store of value, it is a good diversifier. Although the price is cyclical it is becoming a rarer commodity and at time of market stress is the go to instrument.