Posts tagged ‘crystal ball’

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

The Year Ahead

As years draw to a close it is customary for market observers to make early Christmas presents of their thematic predictions. Here are this blog’s thoughts on some major considerations for 2016.

Starting with the obvious: monetary policy will enter what has become very unfamiliar territory for some economies, including those of Britain and the US. Expectations are that the Fed will tighten policy by 25bp next week; as we have seen, the Bank of England is not expected to follow until well into next year. But market expectations are for the gentlest upward path for rates in recent history on both sides of the Atlantic. Anything more than this will come as a major surprise.

On a connected point, oil made much of the market and macro running this year. The key futures were making new sub-$40 lows just this afternoon. But the key point is that the average price over the last 12 months is $55 as against around $100 for 2014. For cheap energy to mimic the disinflationary pattern established this year would require oil futures to trade down to $30 and settle there throughout 2016. That is a real possibility. On the other hand, a change in OPEC / Saudi Arabian policy on supply could see the price start to climb again. Even if it manages to hold its 2015 range of about $40-60, that will still be significant as the “base effects” of cheap energy on inflation will fade away. In other words the oil price is set to remain a key metric for the world next year – and is entirely unpredictable.

Talking of unpredictable, the election of the next American President is already making headlines almost a year before the event. It will inevitably hog the political limelight in 2016. But elections and electoral arithmetic in Europe are much more interesting from an investment perspective. In several countries, “right-wing populist” or far right parties are riding high in the polls and they tend to be Eurosceptic. We will see how the National Front fares in French regional elections this weekend but there are national elections brewing elsewhere. In Holland, where an election must be held by March 2017 and if history is any guide will take place earlier, the Party for Freedom is polling in the high thirties. In the meantime the Dutch will be voting in an “advisory referendum” come April on the EU’s dealings with Ukraine. There is room for some mild upset on that front and transformational political change at the European level from Holland come the general election. During 2016 the British referendum on EU membership will also be drawing nearer.

Major equity markets showed degrees of volatility this year not witnessed since the crash and panic of 2011. Several currencies had a turbulent time of things too. With the other themes in mind it appears likely that volatility will again feature in 2016.

This list is not exhaustive but will provide us with plenty to chew on over the coming months. In the immortal words of Louis Pasteur: chance favours the prepared mind!

11/12/2015 at 5:40 pm

Themes for 2015

With Christmas almost here and the New Year a little over a week away it is the traditional time for market observers to dust off their crystal balls and treat everyone to their insights on what will happen once that financially significant uptick in the Gregorian calendar has occurred. Accordingly, here are a few themes which this blog believes will be important in 2015.

Debt. Despite a return to the bond market this year, Greece has threatened to become a target of scrutiny again – but amid the wreckage of the credit crunch and Great Recession is far from the only show in town. The collapse in the price of oil this quarter is in part a reflection of the power of Saudi Arabia, with its huge balance sheet reserves, to weather it, as readers will know. On the other hand, those countries with big sovereign debt positions – most of us in the developed world – are hobbled by it.

The US for instance has $12.4trn of treasury instruments outstanding. These are already costing over $400bn in interest each year, a material amount for the budget of even the world’s largest economy. Of that $12.4trn, $4.9trn – almost 40% – matures between now and the end of 2016.

Interest rates. Emergency monetary conditions have already been pared back in many of the countries hardest hit by the events of the last seven years. In the US, the UK and elsewhere, zero or near-zero policy rates are now expected to rise again in the second half of 2015.

With interest payments already high for so many economies, rising rates are an issue, particularly for those whose debt positions are concentrated at the very short end of the yield curve. The burden of debt interest in these cases – already a hindrance to growth via austerity measures and tax increases – will get heavier.

Inflation. With huge capacity overhangs, massive labour market weakness and weak commodity prices, this has not been an issue for most major economies in recent years. However, labour markets in particular are now much healthier than they were even a year ago, and there have been tentative signs already that this has come to bear on price behaviour.

The move down in oil will once more serve to keep inflation in bed for some time, assuming that it does not reverse in the near term. But as economies continue to recover, internal rather than imported price pressures are bound to rise. Markets are not remotely concerned about inflation at the moment. Should this change there will be implications for interest rates across the yield curve and potentially for risk markets too.

Market selection. Risk on versus risk off continues to be an important general theme for markets which remain nervous. But the last couple of years have seen significant divergence between different market types and regions even within that context. In 2014 to date, the US has topped the equity charts for the developed world (+12%), while Asian markets, most notably China (+48%) and India (+31%), have leapt ahead of their emerging peers. More broadly, developed and emerging market equity indices have out- and under-performed each other at various times as the year has gone on.

There is every reason to expect this to continue over next year. As always, sentiment is unpredictable and one cannot plan for black swan events. But bearing in mind the dynamics for growth, the valuation picture and the possible importance of the themes we have already looked at, there are some interesting considerations for portfolios in this area on a fundamental view.

There are of course other questions to think about and apparent anomalies to ponder. These themes should be seen as undercurrents rather than any kind of directional forecast. Market noise aside, however, one or two of them could deliver some material surprises this coming year – pleasant or otherwise.

22/12/2014 at 4:59 pm

Themes For The Future

With 25 December only days away now we might have expected a calm period for markets. The Chinese sometimes enjoy doing things like taking monetary policy decisions on Christmas Day, but whether they are celebrating Christmas, Yuletide or the Holiday Season, western markets and policymakers generally prefer to make a quieter time of it. So it was interesting to see the Fed choose this Wednesday to vote to start tapering off its most recent asset purchase programme.

Fears over tapering reinforced several major market behaviour patterns in 2013, making it one of the year’s key investment themes. Readers may remember the panic which ensued when it was first floated, despite the fact that the Fed’s own research (and calm, thoughtful analysis) suggested that the actual effects of QE3 on the US economy have been negligible. Now tapering is actually to begin, however – from January – market reaction has been quite controlled: the ten year Treasury yield is higher, but only by about 7bp; the trade weighted dollar was stronger by Thursday evening, but by less than 1%; gold fell, but to a price only a little over $10 under its previous low for the year; and the S&P 500 rallied all of 29.65 points on Wednesday before closing yesterday flat.

Speculation, however idle, as to the globally deleterious impact of tapering will certainly continue into the New Year. Perhaps it will continue to have some power as a market theme in 2014. But we have surely reached the point where we can say it is old news. So what other themes may emerge next year?

Growth will be one. This blog has highlighted the importance of a return to growth in Europe, including the UK, in particular. 2013 has already seen the first consecutive quarters of growth across all the major developed economies since 2010. Within the eurozone especially it remains patchy and sclerotic – but better than the alternative, nonetheless. A gathering of momentum in 2014 should see gloom continue to recede from markets which have had to trudge through a bruising and tedious few years. As one rightly respected fund manager put it in his most recent report, when it comes to the rally in developed-world markets, returns “have come from a rerating … But to prosper from here we need growth.”

One other theme which we have followed has been inflation. This has gone right out of fashion as prices have generally been behaving themselves lately. There is nothing to suggest an immediate change here. But a year is plenty of time for labour markets to pick up slack, the more so if the recovery gets a little more earnest – and that alone should begin to see expectations for monetary policy change, whatever happens to other moving parts such as commodity prices. This is a wild card, and like tapering a potentially hazardous one.

A couple of weeks ago we had a look at the impact of higher growth on the UK’s sovereign debt position. There are still countries with serious problems in this area (we might think of Greece in particular), and as a result we cannot discount the possibility of further shocks. But with a more deeply entrenched recovery underway, Britain’s happy story will find other tellers. More and more governments should find themselves closer to balancing, if not actually balancing their books in 2014.

In some cases this will come in the nick of time. Even if inflation expectations do not develop as one of next year’s themes, the burden of debt at the shorter (and cheaper) end of yield curves make higher rates here a potential worry for many borrowers into 2015 and beyond. On the other hand, it is possible that other more problematic sovereigns will join Ireland in revisiting bond markets, putting another stake through the heart of the debt crisis.

Turning to the negative: there were no black swans in 2013. Compared to preceding years this was highly unusual. In 2010 we had the eurozone / sovereign debt crisis, in 2011 the Japanese earthquake and US GDP shock and then in 2012 the Greek elections. These are not things we can plan for. However, with events in the Middle East having moved in favour of Iran this year, and an escalation in tension between China and Japan, it is not obvious that the world has become a materially safer place. In the event that major government bond yields continue to rise a prudent investor (who has been well positioned to date) might look for opportunities to begin diversifying back into these and related assets over the course of next year.

As crystal balls go this one has been kept deliberately opaque. Depending how they play out, these themes could each have very different consequences for market behaviour and the pricing of risk. As a closing observation: even though  it has been relatively benign compared to its immediate predecessors, 2013 has still been a nervous year. It still feels as if a large number of market participants and observers are more at home with setbacks than advances.

Should this change convincingly next year it would be something of a theme in itself. In any event, based on vigilant analysis of the fundamentals and a reasoned understanding of price, it should still be possible to make investment sense of 2014, as it has been for the past few years, in spite of everything.

20/12/2013 at 3:44 pm


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