Market Predictions 2017

The effect of the new US presidency is about as clear as mud and how this plays out over the year can and probably will have massive geopolitical and market ramifications. Whilst the press are cynics as per the above cartoon, markets have lapped it up.

Chinese tariffs, the Mexican wall, infrastructure etc. – there are a lot of moving parts here to say the least (and, of course, some very positive for certain equities). Just one example that hasn’t received as much press – President Trump’s proposed “border-adjusted tax” – If it goes through this will have major implications for certain sectors that import a high percentage of their raw materials. For example, a US clothing retailer that imports goods to on-sell in the US market may have to increase prices by 10-20% to maintain similar levels of profits, despite the company tax being reduced (naturally this will be offset to some extent by expected gains in the USD increasing their buying power). The question is whether Congress will approve this?

I guess the good news for the new administration is that they are coming in at a time when the US economy is strengthening after years of monetary stimulus and employment has firmed considerably (US headline unemployment at 4.7%).

Overall – Can President Trump pull it off? Massive spending, tariffs, border taxes and tariffs, diplomacy “hiccups”, new infrastructure etc. Long term it looks problematic to me but short term markets have effectively voted positively on a reflationary, higher spending and lower (local) US taxed United States. Our gut feel is that this is the biggest market risk factor for 2017. To me it lots like the positive “Trumphoria” feelings will be dented throughout the year as usually happens with a major reform agenda Government is elected. Having said that, this positive momentum can persist for the short term at least – After that reality will set in and growth assets with re-adjust. Our central view is that growth assets will generally produce overall positive, albeit single digit returns in local currency in the develop markets.

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After a remarkable run for government bonds, the new reflationary environment promises to make life difficult for longer duration fixed interest although it’s fair to say some of this has already been priced with bond total returns falling post Trump with the Australian Bond Index down -2.6% since September ‘16 (Bloomberg AusBond Composite 0+Y) driven by rising yields as more inflation gets priced in.

Bonds can still be a good insurance policy if the world turns to goo but overall 2017 will likely be a good time to be invested in shorter duration credit assets. Interest rates are expected to move higher but credit spreads should perform reasonably well as corporate balance sheets are largely in good shape.

Overall – Probably time to (finally) underweight Government Bonds. Credit exposure a better bet, particularly given strong balance sheets.

If you are concerned that China tends to fudge their official statistics then the new Spaceknow index that monitors 2.2 billion individual satellite observations over China to observe actual changes and activity is also holding up well with the index at 51.2 (over 50 implies an expansion). Pressures on capital outflows, debt and property markets will still be observed during 2017.

With some antagonism expected from Trump, the Communist Party congress in the latter half of 2017, held twice each decade probably ups the ante in terms of political risk even though President Xi Jinping and Premier Li Keqiang will remain on the top level standing committee.

Overall – China will manage above 6% GDP growth in 2017 as they slowly move to a new, more sustainable model.

More generally outside of China, emerging markets may suffer under Trump and a predicted stronger US dollar. Potential Trump tariffs and a strong US dollar are a nasty combination and the Trump / Brexit posed threat on globalisation probably will also concern the leaders of these nations. Having said that the steady flow of continued globalisation is likely to occur in the longer term, and whilst President Trump’s policies are generally negative for emerging countries, the need for strong global trade to support global supply chains and consumers increasing desires will still prevail.

Overall – It could be a tough year generally for emerging markets, particularly those with high USD denominated debt which becomes more expensive to repay if the dollar strengthens as is expected.

When we clear away all the US and geopolitical rhetoric, perhaps the simplest and most fundamental question is - will individual companies actually increase their earnings per share? This is crucial as current valuations are already pricing in very high trailing PE multiples. IBES consensus numbers show developed markets earnings growth going from a subdued (estimated) under 1% growth in 2016 to over 12% growth in earnings in 2017 (and emerging markets eps growth from 8% to 14%).

Now the cynics out there will quite rightly point out that in recent years brokers have tended to be overly optimistic months before results and the actual numbers have tended to disappoint (as per the chart below). In terms of our market, the massive swing in commodity prices will at least see part of the earnings growth already baked in but whether we then hit the current 10% forecast is very much predicated on global growth, the continued build-out of the strong housing approvals and a tick up in infrastructure spending.

Chart - Australian share earnings growth forecasts. Shows how forecasts have changed as we get closer to the announced full-year results