Jonathan Marriott – Chief Investment Officer, LGT Vestra LLP
It has been a year of extraordinary events and tragic losses. At the start of the year, a vote for Brexit and a Trump presidency seemed farfetched. The terrorist attacks in France and Germany highlighted the continued danger from Islamic extremists. In Italy, the oldest bank in the world needed to be rescued by a state bail out and a referendum on political reform failed to pass. At the start of the year, concerns were raised about the slowing Chinese economy, falling commodity prices and a global recession. In February, stock markets around the world fell sharply. However, at the end of the year stock markets around the globe were at, or close to, new highs and commodity stocks had performed strongly. As each crisis hit markets reacted less. On the morning of Donald Trump’s victory, equity markets dipped but only for a couple of hours before recovering and rising into the year end. Truly a year when markets appeared to take on the war time poster message of, “Keep Calm and Carry On”. Whether they were right to do so or not is yet to be seen.
The main event in the UK was the Brexit vote but we still have not triggered Article 50 and negotiations have yet to start in earnest. It is hard to see what our trading position with Europe and the rest of the world will be. The economic data so far has held up well and the FTSE 100 is close to an all time high. However, as an indicator of how we will fare on Brexit these are not good measures. In response to the vote the Bank of England cut rates and announced a bond buying operation. The pound fell sharply on the day of the vote and fell further in the months after, only rallying briefly on suggestions of a gradual or delayed exit from the EU. The fall in the pound will lead to higher prices for imports and with the oil price rising in dollars, this means fuel costs will further impact inflation. We should expect annual inflation to rise more than wages in the New Year which will be a constraint on growth going forward. The FTSE 100 index is a very international index, with about 80% of earnings from overseas benefiting from the fall in sterling. A better measure of the UK performance is given by the FTSE UK Local index that only includes companies with over 70% UK sales. This index has fallen by 6.8% where the FTSE 100 was up 14.4% on the year. So far there is more speculation than action on the negotiations and we will have to wait and see what comes in 2017.
Donald Trump’s success appears to be a symptom of a much wider discontent with politicians around the world. Brexit can be seen as a vote against the established order and so can the rise of anti-establishment parties in other parts of the world. We have elections in Holland, France and Germany in 2017 which may give us further evidence of this trend and make UK Brexit negotiations harder. Post the financial crisis central banks intervened to save banks and the global economy. However, the side effect is that low interest rates have boosted stock markets and property prices, making the rich richer but doing little to help the less well-off. In this country we have created a lot of jobs but these are mostly low paid and there remains a skill shortage for better paid jobs which can only be filled by workers from abroad. Thus education and training will be more important than ever in a post-Brexit world.
What Donald Trump means for the US and global economy is not clear. A politician that communicates in late night tweets is something we have not seen before. Despite having a Republican Congress, what he tweets and what he can get through the House may be quite different. So far, equity markets are taking him as broadly pro-business, anti-regulation and likely to spend more on infrastructure and this is seen as being positive for many companies in the US. His trade policy may be inflationary for domestic consumers and less good for emerging markets and other export-led economies. His tax and spending policies appear reminiscent of Ronald Reagan when he became president, however US national debt has ballooned since then and Trump’s room to move on this may be limited. We are told his trade policies and talk of import tariffs may just be a negotiating ploy. Again, we will have to wait and see what actually is done.
Interest rates in the US started to rise at the end of 2015 and rose again in December 2016. While bond yields have risen we have not seen the catastrophic sell off that many predicted. The US Federal Reserve has prepared the ground well for each rise and as a result markets have come to accept the changes. We expect this to continue with only very gradual rate rises. As has been noted above, inflation is likely to rise in the UK as the currency move and commodity price rises feed through. The impact has been delayed by hedges, but will be felt in the New Year. Given the uncertain outlook for Brexit we expect the Bank of England to resist any suggestion of raising rates in response. In Europe, the European Central Bank has extended its bond buying programme and should continue to support markets through a potentially politically difficult year.
As we look out into 2017 and beyond, politics looks as if it will continue to dominate and predicting the outcome, as the bookies have found to their cost this year, is harder than ever. Brexit negotiations, European elections, and a new US president are all likely to complicate the outlook. On the positive side, economic data has broadly held up and with global interest rates on hold or only rising slowly the equity market environment may continue to be broadly positive. However, we should be prepared for more volatility in the months to come and will follow developments closely.