What could the surprises of 2017 be?
A surprise is something the consensus does not expect. Investors are now expecting higher growth and more inflation, the Trump bump. They have invested more heavily in equities and expectations are high.
But demography, final demand and recently sharply higher rates might get in the way. And with the US equity markets having a cyclically adjusted PE of 28, a lot of good news is in the markets. Wall street may not be that great a performer. And with higher rates and a stronger USD, this may be a headwind for stronger profits.
The corollary is that the 10-year US Treasury yield is near the top of its recent range, pushing up borrowing and mortgage costs, which will have an adverse effect on the economy. So the sharp yield rise could be self-correcting.
Investors also have low exposures to Europe and worry about disintegration. Indeed populism might not win and the EU could grow at a stronger 1.6% according to OECD forecasts. Our Event Driven European positions could appear prescient.
There is a broad view that stocks will be up in 2017, the dollar will be stronger, oil will be up, bond yields will be higher and macro trading is back. Everyone likes financials, transports and industrials. The value of being directionally in this consensus may not pay from these levels.
Donald Trump may want to shake up Washington and be aggressive in Q1 to move expectations forward. A risk is that most gains in 2017 will be made in the first few months.
There is uncertainty in Trumps fiscal, monetary and trade policies. Tax, regulatory reform and fiscal stimulus in the US have the potential to support markets strongly, but we should keep directional risk exposure low due to uncertainly.
The Federal Reserve is tightening policy. The US is at full employment, with rising wage pressures and thus rising inflation pressures. Trump is promoting more stimulus although there is no certainty to timing or approved content. While this could be destabilizing medium term, the next significant interruption from a rising trend in interest rates is likely to occur only when central banks tighten monetary policy sufficiently to rein in rising inflation, possibly triggering a recession in the process. For a sense of timing, US 10-Year Bond Yields could rise to 5% within the next three years. If rates rise rapidly we could expect disruption for our UCITS.
Longer term, the sentiment going in to 2017 is ignoring the reality of an aging world. In terms of animal spirits longer term, I still feel strongly that people are underestimating the impact of older populations.