2017 – A year of reflation and rotation

Eight years ago when Barack Obama took the most important office, the world economy was falling off a cliff, the bank sector had been close to a collapse and the future was extremely uncertain. Fast forward eight years, Donald Trump takes over a healthy economy at a time when the business cycle is playing well past halftime.

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Trump is expected to drive through broad tax cuts and remove various regulations over his first term. It is unheard of for current generations, because the country has not initiated fiscal stimulus outside a recession over the past 50 years.

Markets are cheering the expected boost the proposed US economic reforms might bring. Should investors be optimistic or pessimistic about these changes, since the American economic cycle is already late and turning eight years next summer?

At Evli we are optimistic.


Ten market and macro calls

Our investment philosophy is based on detecting market trends and mispriced assets or themes. We can still find positive trends, however, undervalued markets are rare. From an optimist’s view, and with our investment philosophy in mind, we have summarized our key calls listed below. It presents our macro and market themes for 2017:

  1. The global economy in 2017 is in better shape than in five years. Reflation is the macro theme; hence risks are on the upside. Global GDP growth will reach long-term trend levels. The recessionary emerging economies (Brazil & Russia) will return to growth. American growth will accelerate at the end of 2017 and Europe’s economies are in good shape.

  2. The rotation from bonds to equities begins as longer bond yields rise. Government bond returns will be negative. Especially German and other European sovereign yields might increase more in relative terms, as the spreads to US bonds tighten.

  3. Equity returns are strong in 2017. Earnings growth will be at double-digit levels on average, driven by higher growth and rising inflation. Investors have few other choices than stocks after fund flows to bonds have already reached record highs. Market trends are currently positive in almost every stock market. The upward moving equity trend will not be a straight line, but we will see some bumps on the way. Tactical allocation can work in avoiding bigger bumps.

  4. Fiscal stimulus overtakes monetary easing as central banks are pondering the end of massive bond buying. The US Fed is already on a tightening path as growth and inflation are rising. ECB and Bank of Japan will continue to ease but at a slower pace. Fiscal easing will happen in at least the US and the UK, and likely in Germany and France.

  5. Europe’s political uncertainty won’t derail the rise of the equity markets. However, risk levels will be higher. It is highly likely that Le Pen will end up second in France and that Merkel’s CDU wins the German election.

  6. China avoids a hard-landing. Growth will continue to slow but remains at a decent level. The property bubble will not burst in 2017. Commodity prices will continue to advance as the recovery of the global economy raises demand for metals and energy.

  7. Within equities favor undervalued and under-owned themes, which will gain from the rise in bond yields, like cheap value stocks as banks. Also themes related to the US domestic demand story and lesser regulation are interesting, like US smaller companies.

  8. Dollar strength will end in the beginning of 2017. The greenback has already discounted a lot of the positive growth and inflation story, and being long the dollar is one of the most crowded trades at the moment. The rise in US yields might lag those of other countries like Germany. In light of this, the euro is likely to strengthen against the dollar during 2017.

  9. High yield bonds are one of the few places where investors can harvest decent fixed income returns. The credit spreads will further tighten, and the rise in bond yields will not erode the return potential in high yield.

  10. The main risks are somewhat contrasting from previous years. China and commodity markets will remain calmer. Instead higher growth and inflation levels will put upward pressure on bond yields. Extremely low short rates and bond yields have boosted global debt levels to record highs over the recent cycle. A steeper rise in bond yields would be a heavy burden for a global system built on a low interest rate environment.

As always with forecasting, it comes with a great dose of uncertainty. Political risks are “known unknowns”, and with Donald Trump as the “leader of the free world” adds another layer of unpredictability – both for the US and the global economy.

The aforementioned market views are based on our main scenario and can change during 2017. With this in mind, we finish off with an alleged quote from the famous economist John Maynard Keynes: "When the facts change, I change my mind. What do you do, sir?“

 

The key issues as we set our sights on 2019 are the progression of the global economic cycle, the inflation outlook, US and euro area monetary policies, globalization and world trade, political risks, the corporate performance outlook, valuation levels and the status of emerging countries.

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