Archive for December, 2016

A Prosperous 2017?

We began the year with an episode of panic. We end it with something of a Santa Rally. And in the meantime a couple of western governments have fallen at the hands of “populism” and the US has elected her first ever president to have served neither in politics nor the military. Can 2017 sustain this level of interest? Here are some thoughts on themes to watch in the New Year.

First of all: interest rates. The trend in “safe haven” government bond markets has already reversed. The Fed shocked some this week by indicating a forward path for monetary tightening which is not quite as glacially slow as had become customary. So this theme is already underway.

Monetary tightening is an unfamiliar concept these days, however, and its effects are unpredictable. Some key details to watch will be the impact of higher rates, if any, on corporate margins (including for private equity) and mortgage borrowers. The possible influence of higher bond yields on fiscal arithmetic could demand attention, especially here in the UK. Higher yields in the US could have all sorts of side effects on emerging market capital flows, credit spreads and equity pricing, and then there is the possible spillover for the dollar.

Volatility, then, is to be expected. And it is (worryingly?) easy to identify disaster scenarios from this source. A central bank, for instance, which balks at tightening policy too fast and decides to leaven the blow with some cosmetic unwinding of its QE program, panicking risk markets in the process. Or a bank which decides to take a risk on supposedly short term price behaviour and holds back on hiking rates . . .

. . . Fuelling inflation. Now this dog hasn’t barked for years and, to stretch the metaphor, has been blocked in its kennel by barrels of cheap oil since late 2014. Will prices take off, especially in Britain and the US? By how much? How will this compare to expectations? What will the impact be on real wage growth? And fiscal arithmetic? And profit margins? Again, disasters on some or all of these fronts are easy to conjure up. And again, inflation is a rather unfamiliar animal nowadays. Here in Britain it hasn’t even reached the Bank of England’s 2% target for three years.

The consensus for a while has been that equities are a good inflation hedge. This might turn out to be true (though it wasn’t at the time of the major price shocks of the 1970s). But earnings reports will bear close scrutiny next year. Equity markets have been filling themselves with cheer a long, long time before the run up to Christmas. If EPS do not catch up with prices then the latter could prove more vulnerable to an unpleasant surprise.

Political risk looks set to continue as we approach the New Year. Europe is an obvious place to focus on with elections in France having drawn a lot of media attention – though the Dutch will get there first (15 March plays 23 April for the first round of the Le Pen-athon). Geert Wilders is likely to win the most seats but will there be some kind of “grand coalition” to stop him becoming PM? Then there are the usual tensions to consider, as well as the overhanging threat of terrorist barbarity in many parts of the world.

Looking at this little list – interest rates, inflation, earnings and politics – it is easy to contemplate next year with a sense of foreboding. But we should not be too gloomy. President Trump’s policies could prove expansionary for the US economy and positive for Wall Street. After all, its reaction to his election on 8 November has seen the S&P 500 rally by 6% since then. Putting Brexit to one side the rest of the EU could well muddle through the possible electoral upsets of 2017 with Brussels and the euro very much intact. They survived the sovereign debt crisis. Will this be any harder? Note, too, that the Dutch referendum to veto an EU agreement with Ukraine (6 April) has been sidestepped with a certain amount of Eurofudge and a newly minted trade deal, with no explicit possibility of accession, has been agreed only this week. PM Rutte is to put it before the Dutch parliament soon.

Manageable inflation and modest rate rises might not trouble markets unduly. Yes, weak EPS could be the straw that breaks the equity market’s back in the right circumstances. Equally, strong earnings growth could be the icing on the cake. Either way, these are some of the key moving parts to keep our eyes on as the calendar turns over another page. The only advice this blog can give is general, and not really susceptible to the calendar at all: where investors have views on these things they should position for them, with careful thought, and ongoing vigilance.

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16/12/2016 at 4:52 pm


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