Following a tumultuous political year in 2016, with the election of Donald Trump, the UK’s European Union referendum and the Italian Constitutional Referendum, political uncertainty will continue to be a theme of 2017. The French presidential election and German federal election are due to take place in April and August respectively. Both of these events have been marked by the rise of far-right parties (National Front, Alternative for Germany), campaigning primarily for greater immigration controls in the wake of terrorist attacks throughout Europe and the continuing migration crisis. While it is unlikely at this stage that these parties will gain power (although as we saw in 2016, anything can happen), investors and traders are likely to focus on these events, increasing the potential for short-term volatility. However, a likely longer-term impact will be the increasing influence of the far right on the incumbent parties’ behaviour. This has already been seen to an extent with centre ground parties adopting harsher policies towards immigration, inequality and to an extent the EU.
The real impact of last year’s votes is yet to be felt. The UK has not yet triggered Article 50 or begun negotiations on how the UKs relationship with the EU will look like. However, Theresa May has pencilled in March to begin this process. There has been much disagreement on the effect that leaving the EU will have on the UK economy, although it is clear that no one can accurately predict this impact. However, we can be more confident that there will be greater uncertainty in the UK economic and political outlook for some time, which will undoubtedly lead to greater volatility. UK commercial property transactions have decreased sharply, although there has not been a large decrease in values. This indicates that investors are waiting to see what the Brexit negotiations bring before taking further action.
Following a similar theme in the US, the election of Donald Trump for president has received much news coverage; however, he has not yet had the chance to enact policies or engage fully in international affairs. Given his erratic nature and unconventional political beliefs, it is highly likely that there will be periods of heightened uncertainty as a result of his actions or comments and their potential impact on investments. There has been much hope placed on Trump bringing in policies which will stoke inflation and drive economic growth. However, given the extent of this belief, he is likely to disappoint.
US economic growth is likely to continue to be a bright spot in 2017. Donald Trump will inherit a more healthy American economy than any president since George HW Bush in the 1980’s. Furthermore, this will be supported, at least in the short term, by expansionary fiscal policies. The economy continues to add jobs, driving the unemployment rate lower and increasing wages. However, the current Trump fiscal plans will add significantly to the Federal debt which will need to be addressed at some stage and inequality continues to be an issue. The Federal Reserve have guided markets, indicating that there will be three 0.25% interest rate rises in 2017. Increases ahead of this pathway could lead to further appreciation of the dollar and pressure on bond markets.
In the UK there are concerns that political uncertainty and inflationary pressures will dampen economic growth. Consumers, which are the driving force of the economy, will see the tailwind of low inflation removed over the next 12 months as a weak pound and rising fuel costs increase prices. Furthermore, as individuals and business see greater uncertainty in the future, there will be a tendency to hoard more cash, decreasing investment and consumption. This is already beginning to be seen.
Last year saw a historic agreement made by Organisation of Petroleum Exporting Countries (OPEC) along with external countries to cut supplies and support the oil price resulting in a 20% rise in prices. As a result, the oil price is now trading over 100% higher than the lows seen last January. While the oil price is unlikely to rise significantly more, the impact of the rise is yet to be felt. This will have a significant effect on inflation across many developed economies which have benefitted from a falling oil price for over two years. However, investors are now watching to ensure that members adhere to the terms of the agreement. Any sign of foul play will result in a sharp fall in the price of oil.
The most significant potential risk for 2017 comes from China. There were concerns at the beginning of 2016 that the Chinese investment and export driven model had run out of steam and the economy was becoming swamped by bad debt. This problem has not gone away and has only been overshadowed by current events. While the Chinese authorities have vast powers to control the economy, the relative size of the government now means that currency flows as well as the stock and property markets are ever more market driven. While a plan is underway to rebalance the economy towards a more consumption and service driven model, there are risks of an economic shock. Given that China now makes up over 15% of global GDP and a larger proportion of global trade, any domestic issues would ripple around the world.
We enter 2017 with equity markets around the world reaching record highs and bond market yields not far off historic lows. However, we find there are still good opportunities for generating returns going forward by being selective while continuing to be aware of the potential risks.