Candriam’s head of Asset Allocation Nadège Dufossé has identified five challenges for the asset management industry in the firm’s 2017 outlook.
The company expects next year to progress towards the end of the low-growth, low-inflation environment and anticipates an increase in market volatility.
The regime change in the US with the forthcoming Trump presidency should reverberate into the global markets according to Candriam.
“As a result of the US elections, the prospect of increased fiscal easing has risen considerably, given Donald Trump’s programme. Even though the specifics and the size of the stimulus package still have to be nailed down, a dose of US reflation is allaying end-cycle anxieties among market professionals.
“Ultimately, Candriam expects stronger US growth over the coming months. We expect equities to outperform due to rising corporate profits, improved confidence readings and stable equity multiples and we are buyers of US equities. We are adding to Japanese equities, which benefit from improved US outlook and represent a hedge if the US dollar appreciates more than expected,” said Dufossé.
The Brussels-headquartered manager expects this regime shift to likely result in higher inflation and rising wages.
“We expect bond yields to rise in 2017 based on fiscal easing and rising wages in the US, receding Chinese deflation and potential protectionist measures and we are therefore reducing duration, buying linkers and buying value equities.”
Candriam’s head of Asset Allocation said first challenge of 2017 will then be the rise of interest rates and bond yields.
“Fundamentally speaking, sovereign bond yields have become over-valued after 35 years of bull markets. According to research from the Federal Reserve Bank of New York, the term premium of 10y US Treasury yields reached an unprecedented low point last summer.
“If this diagnosis proves accurate, risk has switched from equities to bonds in the form of duration risk. Higher global bond yields would signal reflation, which should not represent an obstacle for stock markets,” she argued.
A second challenge dwells in a policy error risk linked to the outcomes of the forthcoming Trump presidency.
Dufossé explained that an aggressive policy mix could trigger misallocation of resources or an interest-rate shock which would significantly tighten financial conditions.
If bond yields rise too fast and too far, it could result in a sharp tightening in monetary and financial conditions, which would be detrimental to stock market performance.
“Further, the introduction of protectionist measures could swing the pendulum from a “reflationary” environment towards “stagflation”. An interest rate shock due to higher inflation outlook, not supported by rising growth expectations, would signal stagflation.”
Central bank decoupling remains another challenge seen by Candriam’s asset allocation chief for next year.
She pointed out that the expected policy gap between the US and the rest of the world implies re-alignments in currency markets.
“We expect the Federal Reserve to continue, or even accelerate, its tightening, while the ECB, BoE and the BoJ will do their utmost to prevent any adverse spill-over of rising bond yields. The US Fed tightening cycle is at odds with accommodative policy in the Eurozone, the UK and Japan. At the end of the day, this should lead to a stronger USD and a weaker JPY and boost exporters outside the US,” Dufossé assessed.
The fourth challenge deals with the risks being priced into emerging markets.
Even though emerging markets have improved domestically and globally, Trump’s victory put them the region at risk, not only because of potential protectional measures.
“Higher US rates imply downward pressure on currencies, which might result in capital outflows. The valuation yardstick, however, indicates an attractive levels,” Dufossé said.
The last challenge she highlighted is political uncertainties across Europe.
Upcoming general elections in the Netherlands and presidential and general elections in France and Germany might put the integrity of the Eurozone at risk, she said.
“The start of the Brexit negotiations will add further uncertainties to the region and the conditions of the Brexit and its impact on the economy are nowhere near resolved. We note that investor positioning has been rather cautious ahead of the votes in 2016 as cash ratios in portfolios have been historically high and money has been put back to work in the aftermath of the ballots.
“In addition, central banks are now used to following the financial crisis template and are ready to provide ample liquidity to markets, which has reassured market professionals.”