Quarterly Investment Strategy
2016 tested investors’ nerves – what can be expected of 2017?
Financial markets have rarely seen such a bad start to the year as in 2016, with fears of a hard landing in China, falling oil prices, an industrial recession in the US and fragile solvency in the European banking sector alarming investors. As the months went on, however, the global economy demonstrated its ability to avoid these pitfalls and maintain a modest but stable pace of growth, supported by still-accommodative central banks. Political shocks then succeeded economic fears.
At the end of June 2016, the outcome of the UK’s “Brexit” referendum brought home the scale of structural challenges faced by the West: the rise of populism and protectionism, a tense social climate, and a threatened reversal of globalisation and its benefits. These elements subsequently propelled Donald Trump to the American presidency.
Despite this turmoil, our final verdict on 2016 is relatively positive. Solid fundamentals proved enough of a support to the global economy: a conviction we held throughout the year and expressed through a balanced investment approach. It is interesting to note that a defensive stance would not have paid off, given the negative returns shown by the safest government bonds, while an aggressive approach would have suffered in volatile financial markets.
For the new year, we foresee a similar or slightly improved economic scenario, boosted by an expected US fiscal stimulus, provided the Federal Reserve (Fed) maintains a gradual approach to raising rates. Europe should continue to muddle through, despite a busy political agenda that promises tense periods. Emerging markets should continue to stabilise, with strengthening oil prices helping mitigate protectionist threats.
To be sure, long-term economic and financial fundamentals remain hampered by demographic, debt and productivity issues, that are keeping world growth in a state of prolonged stagnation. But this does not preclude cyclical ups and downs: 2016 was at the low end of the range experienced during these low-but-stable growth years, 2017 could well be at the high end.
Does this mean that fears of much higher yields and interest rate levels – so-called normalization – are justified? Our take is that normal rates would only be possible in a normal economy, a far cry from the current situation. Today’s world is simply very different from that to which the post-World War II era has accustomed us.
For all the talk about how to bolster weak demand, held back by demographic and debt issues, it may be the supply-side concerns (lack of productivity) that stand a better chance of being reversed. Expansive fiscal policy is desirable in this respect. Sustained government investment has the potential to improve productivity, provided it is true investment, not just transfers or useless projects. So long as the private sector generates excess savings – which it does despite still low interest rates – governments have an essential role as borrower of last resort. They should borrow to invest in projects that yield more than their own bonds. Such projects will be self-financing and not increase the burden on taxpayers.
All told, as we look out to 2017, we expect what we would call “improved continuity” mainly thanks to reaccelerating growth in the US and (most) emerging economies. We intend to maintain a balanced, rigorous but reactive approach to portfolio management, in order to overcome inevitable episodes of volatility and seize opportunities that arise.
Note: Unless otherwise stated, all data mentioned in this publication is based on the following sources: Datastream, Bloomberg, Lombard Odier calculation.
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