Multi-Asset Outlook 2017: More Growth, More Inflation, More Politics
Paul O’Connor, Head of Multi-Asset, reviews 2016’s lessons, and details the key themes that investors should prepare for in 2017. He explains which areas of the market look most and least appealing from a cross-asset perspective.
What lessons have you learned from 2016?
One key lesson is that investors can no longer rely on successive waves of central bank policy support to keep driving markets higher. The great monetary easing is over. In our view, this implies that many of the trends that drove strong asset returns in the post-crisis years, such as the decline in bond yields, the rise in equity valuations, and the compression of credit spreads, are now close to exhaustion. This doesn’t mean that investors can’t make money in 2017, but it does suggest that returns will be lower and more varied than in recent years. Asset allocation and active management will be more important than ever.
The second key lesson from 2016 is that politics is returning as a major influence on financial markets after more than three decades during which its impact was suppressed by globalization, deregulation, and increasingly free markets. While the market-jolting political events of the last year – most notably ‘Brexit’ and the US presidential election – had their origins in domestic political dynamics, they also reflect a seismic shift in global politics that looks set to reverberate further around the world in 2017 and beyond. Politics is back. This is a regime change.
Themes for 2017: more growth, more inflation, more politics
The global economy looks set to continue its steady post-crisis recovery in 2017, with real growth remaining in the 3-3.5% range for the sixth consecutive year. The good news is that the recovery is broadening, with all of the 20 largest economies expected to grow for the first time since 2010. Still, in Europe and the US, political developments add an unusually high level of uncertainty to the outlook. In the emerging world, China is the wildcard. Although Chinese growth remained resilient in 2016, the threats of a financial accident or a significant loss of macro momentum will be hard to dispel until structural tensions have eased. That will probably be a multi-year story.
Chart 1: Global growth remains range-bound
Source: Bloomberg, International Monetary Fund (IMF) data from 2013 to 2016. 2017 is the consensus forecast. GDP = gross domestic product; real GDP is that adjusted for price changes (i.e., inflation or deflation).
While the trend in global growth remains steady, inflation in the major economies is making a v-shaped rebound. Consensus forecasts predict that inflation in the developed economies should reach 2% this year for the first time since 2012. A key reason for the improving outlook is the stabilization of commodity prices, which have been depressing headline inflation (which includes food and energy) for the last couple of years. The return of inflation to more normal levels in 2017 will boost nominal growth (that unadjusted for inflation) and corporate earnings. It may also erode support for the ‘secular stagnation’ (prolonged slow growth) narrative that has been widely embraced of late. Furthermore, while underlying inflation remains subdued in the Eurozone and Japan, wages and prices are recovering more broadly in the US, which means that any further inflation surprises there will probably put upwards pressure on interest rate expectations.
Chart 2: Inflation – back to normal
Source: Bloomberg, data from 2000 to 2015 from the Organization for Economic Co-operation and Development (OECD). 2016 to 2018 are consensus forecasts. CPI = consumer price index inflation. YoY = year-on-year.