Fra BNP Paribas:
Global market themes for 2017
Global markets head into 2017 with an elevated level of uncertainty, which we see as having been created by:
1. Shifting global political agendas, with a new policy direction in the US, a change of leadership in China, the start of the UK’s negotiations to leave the EU and elections in the major eurozone economies.
2. Changes in major central bank policy: The Fed raising rates and the ECB tapering its quantitative easing programme. China’s foreign currency reserves to decline.
3. Macroeconomic uncertainty, as Trump’s policies impact on trade, and US fiscal stimulus boosts GDP at a time when the labour market appears to be at full capacity. Furthermore, 2017 could be the year for fiscal stimulus with the potential for expansionary fiscal programmes in Japan, UK and Europe.
Volatility is on the rise, but in our view this means opportunities for the diligent, disciplined and prepared investor. As such our key themes for the start of 2017 are:
Theme 1: Global yields to rise along with uncertainty, causing the unwind of the global carry trade The search for yield environment, fuelled by global central bank liquidity, that dominated markets for most of 2016 is coming to an end.
We expect global yields to continue to rise (both nominal and real), driven by the US. With higher rates in the major bond markets, the relative attractiveness of equities and credit will continue to fade, especially with equity valuations appearing stretched and credit spreads so narrow.
In our view the improvement from strong US growth will not be enough to offset the impact of higher yields, especially in European and EM assets. So far, the risky correction has been relatively muted (Table 1), but as real yields rise and political risk increases, we expect a more marked correction in risky asset classes overall. A move in USD real yields up to and beyond 50bp will consolidate a broader risk-off shift.
Theme 2: Dispersion to rise across sectors and markets Across and within asset classes we expect dispersion to rise as the dependency on central bank liquidity weakens, political risk factors rise, rates rise and the macroeconomic outlook adjusts to a world of higher inflation. Dispersion will rise and correlation will fall as the focus on carry shifts to fundamentals.
For example, Chart 2 shows the recent sharp decline in the correlation across the S&P sectors. Even commodity prices, which in the past have been very highly correlated, have dispersed in recent months, driven by the expected infrastructure spending programmes of the US and China. As a result, investors will have to conduct deeper analysis in 2017 when making investment decisions especially in equities, commodities and credit. Name, asset and sector selection will be key.
Theme 3: Higher rates to impact US and eurozone assets differently: eurozone risk premium is rising Rates are rising in the US because of higher growth and inflation, but in Europe rates are rising because of higher yields elsewhere and rising sovereign credit risk. The divergence of fundamentals is likely be seen most in credit markets, where US companies will be able to withstand higher yields without a marked impact on credit metrics. In Europe, earnings growth will be softer and corporates more sensitive to rising yields.
Moreover, heightened political risk in Europe, coupled with potential tapering of asset purchases by the ECB will push up peripheral and semi-core risk premia. This in turn will put further pressure on European banks and pressure on peripheral stocks and credits.
Theme 4: US headwinds for emerging markets – tight USD liquidity Higher US real rates and a stronger broad trade weighted USD will lower USD liquidity globally, which in turn will tighten EM financial conditions. As such EM will struggle in 2017.
The low yielding Asian currencies (SGD, TWD and KRW) appear particularly at risk in response to tightening USD liquidity, a depreciating CNY and the threat of changes to US trade policies. Currencies and assets of the large current account deficit economies (Turkey and South Africa) will suffer from tighter USD liquidity. Moreover, the implementation of trade isolationist policies by the US administration will only exacerbate issues for EM.
As with developed market equities and credit, we see a rise in dispersion across EM, where an emphasis on shifting fundamentals will drive valuations. For example, in spite of the expected headwinds in EM, we think Brazil and Indonesia could provide opportunities in 2017.
Theme 5: USD to break to new highs The tightening stance of the Federal Reserve versus ongoing accommodation by the ECB and BoJ will be supportive for the USD in 2017. The USD already appears slightly expensive on long-term valuation metrics, but in the 1980s, US President Reagan’s policies illustrated that when the US becomes decoupled from the rest of the world, valuation does not constrain USD performance. As a result, we expect EURUSD to reach 1.00 and USDJPY 128 in 2017.
Meanwhile, a strong USD environment will constrain commodity prices, especially oil and gold.
