Market Bulletin (03/01/2017)
When the Roman poet Juvenal used black swans as a metaphor for the impossible, it was because he thought they didn’t exist, leading to the phrase: a black swan event. But Juvenal had not been to Australia, where Europeans would encounter them for the first time in 1697. The story is told in the 2007 bestseller The Black Swan, by Nassim Nicholas Taleb, a statistician and thinker widely credited with predicting the global financial crisis – itself a black swan event. Last year the metaphorical swans made their return; except this time their destination was politics.
Ladbrokes had offered 5/1 odds on the UK voting to leave the European Union and 150/1 odds on the US electing Donald Trump as president. (Fans of English football will note that it had also offered 5,000/1 odds on Leicester City winning the Premier League in 2016.) Markets were taken by surprise too but, despite plenty of grim forecasts, no doomsday scenario materialised. Instead, equity investors enjoyed a stellar year, thanks in no small part to how politics moved the markets.
Among the leading indices, the FTSE 100 was a notable outperformer, rising more than 19%. It owed some of this to the shift in the oil price, which was boosted in November by an OPEC agreement to cut production. A barrel of Brent crude ended the year above $55, after falling below $30 in January. Russian stocks were a major beneficiary, as were oil majors such as Rio Tinto and BHP Billiton.
Yet currency shifts mattered more. After the Brexit vote, sterling dipped dramatically against the dollar, ending the year down by more than 19%. (It also fell steeply against a wider basket of leading currencies.) The impact on UK-listed stocks was profound, as multinationals suddenly looked cheap in dollar, euro or yen terms – the fall in sterling may have represented fears about the UK outlook, but most FTSE 100 companies are only marginally exposed to the UK’s economic performance.
In fact, the UK economy performed strongly throughout the year, apparently unperturbed by the Brexit vote. Revised figures at the end of December showed that growth in the third quarter, the first since the vote, had in fact been at the same level as the previous quarter. Early indications for the fourth quarter showed no signs of slippage. A survey published by Deloitte at the end of December showed that optimism among UK businesses had struck an 18-month high.
For UK investors and savers alike, business confidence and rising share prices stood in stark contrast to the returns offered by savings accounts. Moreover, by the end of 2016, UK inflation had risen to 1.2%, and was widely expected to track higher. In December, Moneyfacts reported that most savings accounts were offering interest rates at less than half the inflation rate – ‘savings account’ risks becoming a misnomer.
It was a historic year for interest rates globally, as a number of leading central banks around the world cut rates to below zero, notably in Japan, the eurozone, Switzerland, Sweden and Denmark. Yet although quantitative easing and low rates placated markets, they failed to produce radical new shoots of growth in Japan and the eurozone (although the latter grew more quickly) – by the end of the year, Japan appeared to be reviewing its policy and the ECB had begun to taper its monthly QE payments.
Donald Trump waded into the rates debate during the US presidential campaign, criticising Janet Yellen’s Federal Reserve for keeping rates low for so long. In December, Yellen introduced what was only the Fed’s second rate hike since the financial crisis, and painted a positive picture of the US outlook. She had many reasons to do so. Under Barack Obama’s administration, the economy has recovered, the unemployment rate has tracked ever downwards to 4.6% and, more recently, corporate earnings appear to be on the up. The positive US outlook means that the Fed is now facing in a different direction to most other leading central banks, and Yellen forecast three further rate rises in 2017; but the Fed will be watching the new president closely.
“We expect the Fed to take comfort from the lack of disruption from their most recent hike, and also from the fiscal stimulus we are expecting from the president-elect – inflation is moving towards their target and the Fed is likely to act as it gets closer,” said Mark Holman of TwentyFour Asset Management.
Donald Trump defies political convention in myriad ways, from never holding political office to threatening the upset of the geopolitical order established in the wake of World War Two. He has also made significant economic promises, among them: to raise US growth to 3–4%; to spend up to $1 trillion on US infrastructure; to cut corporation tax dramatically; to offer a ‘tax holiday’ rate for US companies that bring operations back to the US from overseas; to annul US involvement in at least two major global trade deals; and to place tariffs on goods imported from China and Mexico.
While analysts pored over his initial senior appointments, markets responded decisively. The S&P 500 has enjoyed a stellar run under the Obama administration, but Trump’s win pushed it up to record highs. The index enjoyed its strongest year since the global financial crisis, rising more than 10% – a strong dollar and weak pound meant that translated into 32.7% in sterling terms. Investors particularly like his promises to lower corporation tax, to turbo-boost infrastructure spending, and to deregulate the energy and financial sectors – both sectors performed strongly after his election.
Bond investors were less impressed, and the yield on the 10-year US Treasury has risen since 9 November on expectations he will have to borrow significantly to fund his policies. This has brought yields back to more typical levels, at least in historical terms, and restored one indicator of normality to capital markets – the prices of stocks and bonds are not typically meant to rise together, as they have been doing in recent years.
Birds of a feather
Yet if the US entered a new economic phase in 2016, other leading economies offered more muted outlooks. In Japan, growth was sluggish and the Nikkei 225 rose by less than 4%; although in sterling terms the index rose by 24.6%. In the eurozone, economic growth gradually improved while stocks suffered a mixed year, but in sterling terms the FTSEurofirst 300 rose by 19.4%, thanks to the weakening pound. Despite the shift, the euro was hardly a world-beater itself, and is widely expected to fall to parity with the dollar in the year ahead.
Bank problems in the eurozone persisted through the year and reached a climax in December, when the Italian prime minister lost a referendum on constitutional reform, throwing into jeopardy his hopes of a private sector rescue for Monte dei Paschii di Siena, Italy’s most stricken bank. Instead, the prime minister quit his post and the Italian state will now bail the bank out itself, probably causing some pain to junior bondholders in the process. Other banks await their own rescues.
Politics is expected to remain prominent on markets in the year ahead. Donald Trump will be inaugurated on 20 January, Theresa May has promised to trigger Article 50 of the Treaty on European Union by the end of March, and high-risk elections are due in the Netherlands and France in the first half of the year; while the deliberations of the Fed and Bank of England will continue to draw scrutiny.
Last year was the 400th anniversary of the death of the ‘Sweet Swan of Avon’, better known as William Shakespeare. As we look back on a year of black swans, it is worth remembering that, while politics offered plenty of surprises, leading markets turned in some strong performances, and all the more so in sterling terms. On this note, we offer all our readers a very prosperous 2017.
TwentyFour Asset Management is a fund manager for St. James’s Place.
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