2017 Looking Ahead

Global economic forecasts and how diversification will continue to assist a quality portfolio.

Improving growth and higher inflation have traditionally been positives for risk assets such as equities and corporate credit. However, as we have experienced in recent years, the investment landscape is rarely so straightforward. We expect political uncertainty to extend into 2017, creating market unease and increasing volatility. The path of rates is also unclear, as the central banks of Europe and Japan approach the limits of their monetary policy stimulus. With the prospect of stronger U.S. growth triggering a spike in U.S. Treasury (UST) yields and a stronger dollar, if investors flock to U.S. assets, the normalization of U.S. rates may not proceed as steadily as expected.

Inflation expectations have picked up in the US due to rebounding energy prices and a tightening labour market.

The prospect that tax cuts and increased infrastructure spending will boost growth has reinforced the market’s view that it is likely that prices could rise in the medium term.

Higher dollar yields and a better US global outlook are likely to support the currency in the near term. This is likely to cause a reduction of the $AUD/$USD value with a flow on effect to enhance our exporting returns whereas pressure on our import spending will be likely.

Having said that, there are questions about how high the $USD can actually go. Understanding internal political changes and stability plus relationships with other countries provides a level of uncertainty.

Investment Implications

  • Investors will need to build diversified portfolios suitable for an environment of improving growth, rising inflation expectations, central banks reaching their policy limits and ongoing political uncertainties.
  • We agree with J P Morgan when they state that their expectations regarding major central banks outside of the U.S. to maintain low interest rates, further constraining real returns from cash in the next 12 months. Income generation remains one important objective of asset allocation. Improving growth and rising inflation expectations should be supportive to risk assets such as equities and corporate credit.  
  • The Australian Reserve Bank remains tentatively poised to look towards fractional interest rate rises during the next 12 months. These will be carefully introduced dependent on broad based economic impact and stability.
  • A strong USD typically benefits U.S. assets and penalizes emerging markets; this could set the tone in early 2017. Yet investors should not abandon emerging markets, given their improving economic and corporate fundamentals and attractive valuations, relative both to history and to developed markets

Developed market equities reacted positively to U.S. President-elect Donald Trump’s pro-growth agenda, anticipating a period of stronger economic growth and rising corporate profits. It will take time for a Trump agenda to be enacted, and before policy impacts are eventually felt, but we expect short-term sentiment and flows to lend support to U.S. equities. In Japan, we see global reflation and a weak Japanese yen helping to bolster earnings. Investors could be concerned over politics in Europe but broadening domestic recovery, resilient activity backdrop and corporate fundamentals suggest European equities should catch up in 2017. However, diversification continues to be the most critical investment principle.

Yields on government bonds have fallen to worryingly low levels over the past two years as a consequence of subdued growth and weak inflation. But with the advent of increased fiscal spending and a slowdown in central bank bond purchases, the prospect now is that headline inflation will be rising, not falling. Inflation is like a pan of water slowly heating on a stovetop that has started to simmer but has not yet reached a boil. Headline inflation is likely to return to central bank targets, not to run at excessively high rates for an extended period. As such, we expect bond yields will continue to move higher, exacting further capital losses. Investors should diversify their fixed income by country and sector to mitigate the risks.

With the outlook for global growth improving and inflation modestly rising, yields on government bonds will move higher, inflicting capital losses.

In Summary

Ensure your portfolio remains well diversified including exposure to all major asset classes (Cash, Fixed Interest, Domestic and Global Equities, Property and Infrastructure plus a small inclusion of quality Alternatives) as this will assist to mitigate risk.

Diversification by country and sectors will also assist to support the portfolio’s structure.

In relation to Fixed Interest investments a portfolio benefits from holding a mix of different fixed-income assets including diversified type fixed interest plus global and domestic bonds.

Maintain awareness of global economic changes and highlights .

We are well prepared and looking forward to 2017 as we continue to monitor and map our safe investment course on behalf of our valued clients.

Acknowledgement: J P Morgan -Market Insights

Jenni Anderson