The capital markets are facing a small shift in the direction of interest rates. “Interest rates have reached their lowest point. There will be a moderate rise in yields,” says Jens Wilhelm, member of the board of managing directors of Union Asset Management Holding AG responsible for portfolio management and real estate.
He believes that the situation in the stock markets in 2017 will be characterised by slightly brisker economic activity coupled with growing inflation expectations in Europe and the US.
“This does not mean that there is an end in sight for low interest rates because they will remain at historically low levels, especially in the eurozone,” explains Wilhelm. “But we are seeing a marked change.”
He also believes that political uncertainty and greater divergence between eurozone and US monetary policy will have a significant influence in 2017. “Flexible and international investment is the order of the day,” advises Wilhelm.
“The US presidential election ended with a bombshell that could have an enormous impact on the capital markets in the coming year,” emphasises Wilhelm. “Since it became clear that Donald Trump would be moving into the Oval Office, the stock markets have been pricing in rising inflation rates.”
Market players anticipate that the new administration will temporarily stimulate the economy with a programme of spending, which will fire up inflation in the US.
Trump and the US economy: positive short-term effects
Wilhelm calls for the expected changes to be examined carefully: “A distinction has to be made between the short-term and long-term consequences for US growth. An additional boost to growth of around 1% is in fact predicted for 2017.”
On the other hand, the budget deficit will increase as a result of high expenditure. Moreover, greater protectionism will hold back growth in the medium term, thereby weakening the economy. “The bill for all of this will only arrive later on, so it is not yet a factor for the stock markets,” says Wilhelm.
Overall, the growth in US gross domestic product (GDP) is likely to remain modest at 1.8% next year. “Trump’s change of direction for economic policy will not solve the US economy’s long-term problems,” stresses Wilhelm. “Productivity weaknesses and the low level of private investing activity will remain a major impediment, even in times of government spending programmes.”
Fed: interest-rate rises ahead, but the dollar will be a constraining factor
Interest-rate forecasts for the US have changed fundamentally following the surprising outcome of the presidential election. Wilhelm now expects the US Federal Reserve (Fed) to raise the key lending rate on up to three occasions: “The rate rise in December is bound to happen, to be followed by one or two more increases next year.”
However, he does not believe that rates will rise steeply, not least because the Fed is likely to keep a very close eye on the future course of the US dollar. “Our view is that the US dollar is going through a phase of strength and may reach parity with the euro,” says Wilhelm. “An appreciating dollar will put the brake on growth – something that the Fed will not ignore.”
US yields climbing at a slower pace
Wilhelm predicts that yields on US government bonds will rise moderately: “We expect yields on ten-year bonds to be at 2.8% at the end of the year.” This means that the US is heading for an interest-rate level not seen since late 2013.
Political tension in Europe
Looking to Europe, Wilhelm highlights the political risks in view of the elections looming in three major eurozone countries (France, the Netherlands and Germany).
“Populists are also gaining ground in Europe, and nobody yet has a plan for Brexit. Ongoing political turmoil is therefore inevitable,” stresses Wilhelm.
He believes that it will become increasingly difficult to anticipate political developments and, above all, their impact on the capital markets, making it all the more important to take a flexible investment approach that allows quick reactions.
Despite the many political challenges, Wilhelm thinks that the European capital markets do offer opportunities. He describes the economy as robust and predicts that GDP in the eurozone will rise by 1.5% compared with the previous year.
“Increased exports to the US should mean that European companies also benefit from the Trump effect,” he says. Moreover, the monetary policy of the European Central Bank (ECB) will remain loose. “Mario Draghi will extend the bond buying programme beyond the spring,” believes Wilhelm. The currently much-discussed ‘tapering’ of purchases is not yet realistic in his view, although he does anticipate that inflation will increase slightly.
Small rise in yields on Bunds
Against this backdrop, the European bond markets are likely to face much smaller yield increases than their US counterparts. “German government bonds remain the safest haven in the eurozone, which means that yields are limited,” says Wilhelm, who predicts 0.7% on ten-year Bunds at the end of the year.
“In Europe, we are also seeing a small shift in the direction of interest rates, although they remain at a very low level,” he adds. He is far more dubious about bonds from eurozone periphery countries, where yield pick-ups and thus falling prices are likely – particularly in phases of political uncertainty surrounding the elections.
Corporate bonds remain well supported
By contrast, the environment for corporate bonds continues to offer good prospects. “A manageable level of inflation and moderate growth are no bad thing for corporate bonds,” explains Wilhelm. “The support provided by the ECB’s bond buying is also having a positive impact. However, this asset class is now very ambitiously priced due to the sharp price rises seen in recent years.”
Price potential for equities; commodities offer opportunities
Wilhelm also remains optimistic about equities: “US stocks, in particular, are rallying on the back of Trump’s election.” Given the healthy state of the economy, he expects profit increases of 5% for US companies and 7% for eurozone companies. Furthermore, he believes that equities continue to be priced cheaply, especially in comparison with bonds. “Equities will remain a vital source of returns next year,” states Wilhelm.
This year has been a good one for commodities, and Wilhelm believes that this asset class still offers opportunities. If OPEC agrees on a cap on oil production, the crude oil market will, according to Union Investment’s forecasts, be well on track to achieving a balance between supply and demand.
“A price of US$ 55 for a barrel of Brent Crude is definitely possible once the production surplus has been used up,” is Wilhelm’s analysis. “The supply-side cuts in recent years are having a positive effect on industrial metals and some precious metals.”
Emerging markets: selection is key
Wilhelm only partly shares the scepticism about the emerging markets, which has increased significantly since the election of the new US president.
“A stronger US dollar and a more inward-focused US economy will create a headwind for the emerging markets,” he explains. “On the other hand, these countries have weathered the perfect storm of a firmer US dollar, weakness in China and falling commodity prices over the past three years.”
He sees this as a sign that the segment has become much more robust. “Nevertheless, differentiation will be even more important in future when it comes to investing in the emerging markets,” emphasises Wilhelm.
Basic investment principles for 2017
According to Wilhelm, 2017 will be a year in which flexibility pays off. Significant volatility is likely in all market segments.
“The latest multi-asset solutions are the instrument of choice in this challenging capital market environment because they allow investors to react flexibly and seize opportunities at short notice,” says Wilhelm.
“Now, more than ever before, it is worth looking beyond Europe.” And finally: “Following Trump’s election and the vote for Brexit, investors should be prepared for reflation. We expect interest rates to continue rising slightly and for equity markets to head upwards, albeit with some fluctuation,” concludes Wilhelm on a positive note.