We anticipate a challenging investment environment in 2017. Near-term, the team believes global economic growth is likely to improve, spurred by fiscal stimulus as political leaders worldwide move away from austerity. Longer-term, however, they think the prospect of trade protectionism raised by Brexit and the U.S. presidential election could mean slower growth and higher inflation.
Buckle up for what could be a roller-coaster investing ride in 2017. We will watch closely for evidence that markets have moved too far into fear or euphoria and look for downside protection when it is cheap.
UK: growth outlook below market expectation, with all eyes on the path of Brexit
Where the UK ends up on the Hard or Soft Brexit spectrum is critical because of the amount of economic and financial disruption that could increase if the UK moved towards a Hard Brexit. The firm believes that while risk of a UK recession has declined, it expects growth to slow significantly and is predicting a growth rate slightly below consensus between 0.8% and 1.2%
All in all, the forces pulling the UK back from a Hard Brexit are every bit as formidable as those pushing towards it. Unfortunately, for now we simply have to wait and see how these competing forces play out. While equity valuations remain slightly cheap, we are maintaining a small underweight position in UK equities. For fixed income investors, they should take note of the balance between near term oversold sentiment signals and medium term slightly expensive valuations.
US: equity valuations expensive, and anticipation of Trump stimulus could lead to an extended overbought period
In the US, Russell Investments highlight Trumponomics is untested and they believe too much stimulus could overheat the US economy, resulting in more Fed tightening and an economic downturn in 2018. They see equity market valuations as already expensive, and they caution that euphoric anticipation of Trump stimulus could lead to an extended overbought period.
Trumponomics is directionally pro-growth, pro-inflation, and our central scenario is a net addition of half a percentage point to real GDP growth. We believe corporate profit growth is likely to be in the mid-single digits at best, while currently high margins may feel pressure from rising labour costs and a stronger dollar. Against this backdrop, we favour Europe and Japan equities over the US in global portfolios, and expect expensive US valuations to limit future market performance.
Europe: equities are slightly cheap in absolute terms; closed underweight position in core European bonds
On the outlook for European financial markets, Russell Investments is positive on the region’s outlook due to favourable fundamentals. It believes Eurozone equities are slightly cheap in an absolute sense and outright cheap relative to the U.S. Meanwhile, its investment division has closed its underweight position in core European bonds following yields rising slightly above the team’s year-end target of 0.2%. In 2017, they are predicting core bonds to remain range-bound at 0% to 0.5% and peripheral bonds at 1% to 2%.
Waiting for outperformance in Eurozone financial markets has felt like waiting for Godot. Over the past year, every time it looked like an upward trend had been established, something caused it to falter. However, fundamentals have remained favourable in 2016 and this combined with attractive valuations continue to point to an overweight position to Eurozone equities. Looking ahead, the political risks need to be monitored, but we are optimistic there will not be any surprises in the Eurozone next year along the lines of the Brexit vote outcome or US President-elect Trump’s victory.
Asia-Pacific continues to both deliver and promise steady economic growth, with a similar steady rate of growth in 2017 expected. Against this backdrop, the long downtrend in inflation and in official interest rates is coming to an end across much of the region, and Russell Investments therefore believes Asia-Pacific equity markets continue to offer moderately good value.
Currencies: following a surge in the US dollar since the victory of Donald Trump in November’s U.S. presidential elections, there could be an overshoot of the dollar which could rival Ronald Reagan’s first term as president in the 1980s. However, the team do not think such an overshoot is a likely scenario.
Wouter Sturkenboom, senior investment strategist EMEA, at Russell Investments