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Global equity markets have recovered from the lows of early February which were associated with concerns over Chinese growth and are now up mid-single digits in local currency terms year to date. More recently, equity markets at the headline level have generally reacted positively to the election of Donal Trump as US President and shown modest gains since the election although within equity markets there has been more significant rotation between sectors with cyclical related stocks outperforming on hopes of improved growth at the expense of more defensive areas of the market.
The recent election of Donald Trump as US President has changed the potential outlook for equity markets in 2017 with wider tail risks both to the upside and downside depending on the policy path adopted by the new US administration. On the upside, greater fiscal stimulus is now likely although there is still a lack of detail regarding the actual fiscal programme which will be implemented in the US. If President elect Trump’s most recent fiscal proposals are implemented in full without any negative trade restrictive policies being put in place, there could be 10% upside in equity markets from current levels. However fiscal conservatism among Republican congressional members and difficulties in fully funding Trump’s more aggressive fiscal easing measures probably reduces the probability of a relatively large fiscal package being implemented. Fiscal multipliers are also likely to be relatively low in any fiscal programme which is announced given the current stage of the US economic cycle and the specific tax measures which currently appear to be on the table. Thus the potential boost to US GDP growth from the ultimate fiscal programme implemented is likely to only be in the region of 25/30bps which is more modest than appears to be currently discounted in the market. As a result the overall boost to global economic and earnings growth is also expected to be limited.
On the possible negative side, trade restrictions to the extent proposed by Trump during the election campaign if fully implemented would have significant negative consequences for global growth, possibly pushing the US and other regions close to recession and thus leading to declines in equity markets. Post the election however, rhetoric on trade restrictions by Trump has been notably lacking, suggesting that the more aggressive trade proposals made during the campaign will not be implemented.
Greater clarity is required on Trump’s policy mandate to confidently predict the outlook for global equities in 2017. With positive growth implications from whatever final fiscal package is introduced in the US and with less extreme trade restrictions likely compared to those that were suggested during the campaign, downside risks to equity markets have been reduced. However other issues continue to overhang equity markets such as valuations being full in absolute terms, the expected reduction in monetary policy support from global central banks in 2017, potential political risks in Europe over the course of the year, ongoing uncertainty over the impact of Brexit and potentially slower growth in China in 2017 all potentially limiting the extent of upside in equity markets over the next twelve months. Given the above issues, volatility is likely to remain a feature in markets through 2017. In terms of the most likely return from global equities in 2017, low single digit returns in local currency terms is considered as being the highest probable outcome with upside therefore remaining limited although there are risks around this expected return. The eventual path of US policy and developments in the various risk factors will determine if and how markets vary from this potential return path with sharp or extreme moves over the course of the year possibly presenting investors with opportunities to enhance returns at various points through 2017.
Global and European sovereign bond yields generally hit new all-time lows immediately after the Brexit referendum in July this year. Since then global bond yields have drifted higher on the back of improving global growth in the second half of 2016 and a rise in inflation due to the base effects of higher oil prices in 2016 compared to 2015.
This trend towards higher yields was exacerbated by Donald Trump’s election as US President. The expectation of a boost to US and global growth through fiscal stimulus has contributed to a further rise in inflation expectations and hence higher yields. In addition, the expected reduction in global central bank monetary policy accommodation in 2017 and anticipated increased issuance of US bonds to fund the additional fiscal spending has led to higher yields, particularly in the US with 10 year Treasury yields rising to 2.38% which in turn has pulled global bond yields higher.
Core Eurozone bond yields however have not risen to the same extent as those in the US with the German 10 year yield only currently at 0.28%. Given the low prospects for fiscal stimulus in Europe and with large output gaps remaining in most European economies, inflation in the Eurozone is expected to remain well below the ECB’s target of close to but just below 2%. While tapering or a reduction in the current level of ECB asset purchases of €80bn per month is possible over the course of 2017, an extension of asset purchases beyond the current scheduled end date of March 2017 is expected to be announced shortly. As a result, with the ECB remaining as a significant buyer in the market, while upward pressure on core Eurozone bond yields is expected in 2017, this is anticipated to be more limited than in the case of the US where 10 year Treasury yields are expected to trade in a range of 2.5/2.9%. In this context, German 10 year yields are expected to trade in a range of 0.25/0.5% in 2017. Trends and developments in the oil price, Eurozone inflation readings, ECB policy announcements and other economic data will determine where within the range yields are trading at any particular point.
Political developments and ECB policy announcements will determine whether peripheral bonds can outperform core bonds in the Eurozone over the medium to long term. Our base case is that despite periods of political uncertainty through 2017, ultimately these will pass without any systemic risk to the EU or Euro and with continued, although possibly a reduced level of ECB bond buying over the course of 2017, peripheral spreads against Germany can narrow over the course of 2017 from current levels.