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2017 GLOBAL INVESTMENT OUTLOOK
BRUSSELS
THE WORLD AT A CROSSROADS
LUXEMBOURG
Economic growth is poised to accelerate – if populist
politics and protectionist trends don’t cause a slowdown
LONDON
MADRID
MONACO
MUNICH
PARIS
GROUP FOOTPRINT
A M S TER DA M
B RUSSEL S
LO N D O N
LU X EM BO U RG
M A DR I D
M O N ACO
M U NI CH
PA R IS
I N T EG R AT E D ACR OS S EU R O PE . H E A D Q UA R T ER E D I N LU X E M B O U R G .
2
3
2017 GLOBAL INVESTMENT OUTLOOK
GROUP HIGHLIGHTS
2,000
EMPLOYEES
400
PRIVATE
BANKERS
1949
175
INVESTMENT
SPECIALISTS
50
CITIES
IN EUROPE
1949
4
4
1949
CONTENTS
6
WELCOME FROM THE GROUP ASSET ALLOCATION COMMITTEE
8
THE WORLD AT A CROSSROADS
18
34
46
•
GLOBALIZATION & ITS DISCONTENTS
•
MAN VS. MACHINE
MACROECONOMIC OUTLOOK
•
THE WORLD IN 2017
•
FISCAL & MONETARY POLICY
•
EUROPE
•
THE UNITED STATES
•
JAPAN
•
CHINA
•
EMERGING MARKETS
INVESTMENT OUTLOOK
•
EQUITIES
•
FIXED INCOME
•
NON-TRADITIONAL ASSET CLASSES
•
COMMODITIES
•
CURRENCIES
GROUP CONTACT INFORMATION
This document has been prepared by KBL European Private Bankers. The statements and views expressed in this
document – based upon information from sources believed to be reliable – are those of KBL epb’s Group Asset
Allocation Committee (GAAC) as of December 1, 2016, and are subject to change. This document is of a general
nature and does not constitute legal, accounting, tax or investment advice. All investors should keep in mind that
past performance is no indication of future performance, and that the value of investments may go up or down.
Copyright © KBL European Private Bankers 2016. All rights reserved.
5
2017 GLOBAL INVESTMENT OUTLOOK
WELCOME.
T
he Group Asset Allocation Committee of
KBL European Private
Bankers is pleased to share
our views on the 2017 global
investment outlook.
As you will read in the following pages, we believe
that the global economy is
at a crossroads. Following
recent modest improvement, 2017 will mark either
the start of a slowdown or
slightly accelerated expansion. We expect the latter,
based on a recovery in industry and energy, higher
consumer spending and reduced austerity.
In Europe, early indicators
suggest annual growth of
roughly 1.5%, in line with
2016, though much will hinge
on the outcome of elections
in three of the eurozone’s five
largest economies, as well as
the ongoing consequences
of Brexit.
6
Despite a world of risks, our outlook for 2017 is positive
In the US, the Trump administration is likely to prioritize
tax reform, infrastructure
investment and defense
spending, supporting midterm expansion. Overall, we
expect US growth to accelerate, reaching 2.4% in 2017,
up from some 1.6% in 2016.
In the face of a massive demographic challenge, we ex-
pect Japanese GDP growth
to stand at 1.2% in 2017.
Meanwhile, China’s economy
may be in transition, but the
pace of expansion should
remain robust – as it will in
emerging markets, where,
after years of stagnation and
decline, the outlook has finally turned the corner.
Investors
should
expect
heightened volatility, which
presents its own opportunities, especially short-term
ones. In addition to identifying a range of preferred equity sectors, sub-sectors and
style plays, we see special
promise in commodity-exporting emerging markets.
Given the highly volatile
environment, bondholders
should brace themselves for
a challenging 2017, when
Trumpenomics will almost
surely lead to rising yields.
Meanwhile, following five
years of steady declines and
significant industry consoli-
Stefan Van Geyt
Group CIO
othbury
Av. Herrmann Debroux 46
E FoundersB-1160
Bruxelles
Court,
Lothbury
Belgique
Londres EC2R
7HE
y.com
www.pldw.be
Royaume-Uni
www.brownshipley.com
43, boulevard Royal
dation, the commodity price
outlook for 2017 is now favorable.
After reviewing the diversification benefits of alternative strategies, we turn
to currencies, where the
outlook is neutral for both
the euro and US dollar. We
believe sterling will face
strong headwinds in 2017.
Over the same period,
commodity-linked currencies should recover.
While we are confident about
our overall asset allocation
strategy, we recognize that
Frank Vranken
Chief Strategist
Keizersgracht 617
Pacellistrasse 16
Luxembourg
Av.L-2955
Herrmann
Debroux 461017 DS Amsterdam
43, boulevard D-80333
Royal Munich
Allemagne
Luxembourg
Pays-Bas
B-1160
Bruxelles
L-2955 Luxembourg
www.merckfinck.de
www.kbl.lu
www.gilissen.nl
Belgique
Luxembourg
www.pldw.be
www.kbl.lu
Ineke Valke
Chief Strategist
Keizersgracht 617
1017 DS Amsterdam
Pays-Bas
www.gilissen.nl
no one can perfectly predict
the future, particularly over
the course of a full year. Indeed, we see three core risks
to our anticipated 2017 scenario: a rising tide of populism in Europe, a potential
bond-market crash, and one
or more major cyber attacks.
For further information in this
regard, please do not hesitate to contact one of our
private bankers in any of the
50 European cities where KBL
epb is present.
Wishing you all the best in
2017,
Robert Greil
Chief Strategist
Pacellistrasse 16
D-80333 Munich
Allemagne
www.merckfinck.de
7
2017 GLOBAL INVESTMENT OUTLOOK
THE WORLD AT A CROSSROADS
Supporters of globalization highlight how the growth of international commerce has
led to an equally meteoric rise in worldwide per capita income. Critics, on both the
left and right, challenge that notion by pointing out that wealth is far from equally
distributed – with the top 0.7% controlling more than 40% of the world’s riches.
Globalization’s discontents clearly drove the UK’s Brexit vote and the surprising
outcome of US elections. Meanwhile, across Europe, populist parties continue
to move from the fringe towards the mainstream, especially in countries such as
Switzerland, Austria, Denmark and Finland.
While it’s impossible to predict how far and wide such movements will ultimately
spread, some believe that the current economic order – founded upon free-market
capitalism – now faces the greatest existential threat since the Cold War.
The world is now at a crossroads. Over the coming months – particularly as much of
Europe goes to the polls – we’ll have a clearer sense of our future path.
A RISING TIDE LIFTS ALL BOATS
Global merchandise
exports
& per
capita
income
(in USD)
World GDP
surfing
the
wave
of merchandise
exports
Thousand
Trillion
18
10
16
9
14
8
12
7
10
6
8
5
6
4
4
3
2
2
1
1960
1970
Global merchandise exports (LHS)
Sources: World Bank & OECD
8
1980
1990
2000
Global per capita income (RHS)
2010
2015
22.9%
13.7%
7.7%
42.3%
0.7%
41.0%
SHARING THE WEALTH
Global wealth distribution (by income group)
42.3%
41%
13.7%
3%
<$10,000
$10,000-100,000
$100,000-1 million
>$1 million
0.7%
7.7%
22.9%
68.7%
Sources: World Economic Forum & Global Wealth Report
NATIONALISM ON THE MARCH
Support for nationalist parties in most recent domestic elections
4%
4.7% 7%
8%
10%
13%
14%
18%
21%
29%
Source: BBC
9
2017 GLOBAL INVESTMENT OUTLOOK
GLOBALIZATION
& ITS DISCONTENTS
The rise of populist politics threatens to
reshape worldwide trade flows and upend
the current economic order. How can
investors navigate this period of sustained
uncertainty?
B
ack in July in Cleveland, Ohio, Republican
delegates from the 50
states gathered to nominate
their unlikely candidate.
Even more unlikely was the
European odd couple in this
star-spangled crowd: a platinum-haired Dutchman and
unassuming Englishman, all
but lost amidst the sea of
Stetson hats and cherry-red
baseball caps proclaiming
MAKE AMERICA GREAT
AGAIN.
10
In retrospect, the world
should have taken greater
notice of far-right Dutch politician Geert Wilders and Nigel Farage, the face of Brexit,
at the Republican National
Convention. The arc of history is long, however; back
then, few serious observers
were predicting populism’s
broad and worrying rise.
Today, the backlash against
globalization couldn’t be
clearer – and we probably
should have seen it coming.
As Harvard scholar Dani Rodrik presciently noted in 2011:
“When globalization collides
with domestic politics, the
smart money bets on politics.”
Across much of the world, the
anti-elitist right is on the rise.
Croatia, Hungary, Poland and
Slovenia have already voted
in rightist governments. Anti-establishment nationalists
are likewise gaining ground
in France, Germany and the
Netherlands. Even the gentle Scandinavians are flirting
with the fringe.
The world’s fastest-growing large economy, India, is
run by a Hindu nationalist.
And in the Philippines, potty-mouthed populist Rodrigo
Duterte won the presidency
by promising his own brand
of law and order.
Britain, of course, is Brexiting. America’s got Trump.
While it’s impossible to predict how far and wide such
movements will spread, it’s
worth taking note of the
French economist Thomas
Piketty’s claim: “At the heart
of every major political upheaval lies a fiscal revolution.” Business and markets
are certainly scrambling to
make sense of this new paradigm, already separating the
likely losers from the winners.
Despite concerns that a
Trump victory would lead to
an immediate sell-off on Wall
Street and elsewhere, equity
markets appeared unruffled
in the two weeks following
the election – when both
the S&P 500 and STOXX
600 moved slightly upwards.
Meanwhile, by mid-November, the dollar had hit 13-year
highs, driven up by rising US
government bond yields.
Never mind the very short
term. What do we expect in
the next 12 months?
For argument’s sake, let’s as-
11
2017 GLOBAL INVESTMENT OUTLOOK
sume that the angry new nationalists will continue to record incremental gains – but
that Marine Le Pen won’t be
holding court in the Élysée
Palace anytime soon, that the
anti-immigrant Alternative for
Germany Party won’t sweep
to office, and that Wilders and
his Freedom Party won’t “take
back their country.”
Let’s also assume that trade
barriers will indeed go up,
starting with countries with
which the US runs the largest
bilateral deficits, including
China (Trump’s public enemy
number one) and Mexico (a
close second), followed by
slightly lesser evils like Canada, Germany, Japan and
South Korea. The Trump
administration may not slap
45% tariffs on Chinese imports or 35% tariffs on Mexican goods, but higher import
taxes appear inevitable.
Whether such actions prove
heavy-handed matters greatly; even more important is
how the other side reacts:
China has already warned of
a “tit-for-tat approach” to
any US action, underlining
what Black Swan author Nassim Nicholas Taleb has described as the “interlocking
fragility” of globalization.
In any event, a further slowdown in global trade looks
likely, compounding anemic
levels of world trade volume growth over the past
four years. During that period, volumes grew by barely
3% annually, less than half
the average rate of expansion over the previous three
decades. Today, economic growth is increasingly a
reflection of activity within
THE WORLD GOES TO THE POLLS
2017 election calendar
12
COUNTRY
TYPE OF ELECTION
DATE
Czech Republic
Parliamentary
October (expected)
France
Presidential/legislative
May/June
Germany
Presidential/parliamentary
February/September-October
India
Presidential
July (or earlier)
Iran
Presidential
May
Netherlands
Parliamentary
March
Norway
Parliamentary
September
South Korea
Presidential
December
A FURTHER SLOWDOWN IN GLOBAL TRADE
LOOKS LIKELY, COMPOUNDING ANEMIC
GROWTH OVER THE PAST FOUR YEARS
national borders rather than
across them.
While sluggish cross-border
trade won’t support global
expansion, we nevertheless
expect worldwide GDP to
accelerate slightly in 2017, reflecting generally improving
fundamentals and anticipated higher levels of domestic
spending.
In developed markets, the
focus on income inequality
should lead to tax breaks
for the poor and middle
class, creating inflationary
pressure and bringing ultra-loose monetary policies
to an end. In emerging markets (EM) – where globalization has been working
for decades and the rise of
Western populism is mostly viewed with headshaking dismay – the current
recovery should continue,
although a sustained US
dollar rally could lead to a
decline in EM asset values.
For investors, this is a complex
backdrop that will be marked
by heightened volatility, which
presents its own opportunities,
especially short-term ones.
If Trump implements the key
planks of his platform, US
exporters will certainly suffer
in 2017, as will renewable energy, consumer staples and
healthcare services.
US financial shares have already recorded significant
gains since Trump’s election.
It remains to be seen if further outperformance will be
recorded in 2017.
Broadly speaking, firms that
are
strong
domestically
should see brighter prospects than those that are
dependent on international trade or overseas profits.
Additional
infrastructure
investment is likely to support the construction sector,
while defense, “old” energy,
mining, pharmaceuticals and
insurance are also likely to
benefit. Commodities, after
years in the doldrums, should
continue to recover.
In the kind of scenario we
anticipate, cyclical stocks
will beat defensive ones.
Value stocks, which tend to
outperform during periods
of economic expansion, will
likewise beat growth shares.
While the fixed-income outlook is extremely challenging,
inflation-linked bonds will
hold greater appeal, particularly given inflation expectations in the US, where we
anticipate at least two Federal
Reserve rate hikes in 2017.
Of course, at this especially
interesting moment in world
history, it’s impossible to predict precisely how the future
will unfold. Indeed, if there
is one thing that unites the
world today it’s the near-permanent state of uncertainty in which we all live. n
13
2017 GLOBAL INVESTMENT OUTLOOK
MAN VS. MACHINE
Global
employment
growth
has
long
outpaced the expansion of the world’s
population. The rise of digitalization, and
especially ‘smart’ robotics, could see such
progress come to a grinding halt
W
ith market caps
of roughly $350
billion, ExxonMobil and Facebook are
a pretty even match. However, the energy company employs five times as
many staff as its social media peer – one key reason
why Facebook’s operating
profit margin is some 400%
higher than that of ExxonMobil.
14
Today, while technology
firms account for four of the
top five places in the Fortune 500, none comes close
to making it on any list of the
world’s largest employers.
Walmart employs over 2
million people worldwide,
Amazon fewer than 270,000.
Hilton, with a portfolio of
650,000 rooms, has 150,000
employees on its books;
Airbnb, with 2 million properties, has a global staff of
just 2,500.
Over the past half-century,
the earth’s population has
grown dramatically. During
the same period – as real
GDP and per capita incomes
have demonstrated a sustained upward curve – employment has expanded at
an even faster pace.
That was due at least partly
to the rise of new technology. Indeed, while earlier
debate about the digital
divide highlighted inequalities between developed
and developing markets
– in areas such as Internet
and smartphone penetration – new technology
spurred massive job creation, especially in the developing world.
That may change, sooner
rather than later.
The impact of outsourcing
and offshoring on worldwide employment may ultimately pale in comparison
to the disruption caused
by next-generation robots,
powered by artificial intelligence – a $32 billion market
today, forecast to exceed
$80 billion by 2020.
The World Economic Forum
has predicted that such new
technology could eradicate
5 million jobs in 15 major
developed and emerging
economies by 2020.
The pain is likely to be particularly acute in developing
markets – until now the engine of global job creation.
“The increased use of robots
15
2017 GLOBAL INVESTMENT OUTLOOK
THE RISE OF ROBOTS IN DEVELOPED
COUNTRIES COULD ERODE THE LABOR-COST
ADVANTAGE OF DEVELOPING COUNTRIES
in developed countries risks
eroding the traditional labor-cost advantage of developing countries,” the United
Nations recently warned. “Adverse effects for developing
countries may be significant.”
Consider the decision by Adidas to shift some production
from China back to Germany
because advances in robotics
make it cost-effective to do so.
The €17 billion sportswear
company recently opened its
first robotic shoe manufacturing warehouse in Ansbach,
Germany, and plans to build
additional robot-staffed factories in other markets, enabling faster delivery to customers.
At a time when global trade
flows are down and protectionist barriers risk going up,
EMPLOYMENT TERMINATOR?
Industrial robot sales (in thousands of units)
developed markets are likely
to benefit from trends like
these, at least in the short
term, as domestic production
increases.
H o w e v e r, A d i d a s - s t y l e
reshoring will increase profitability without creating many
manufacturing jobs – further
fueling populism’s current ascent. This is one of the peculiarities of our age: technology is exacerbating current
levels of income inequality
and, at the same time, giving
voice to those who oppose
such trends.
250
200
150
100
50
0
2004
2005
Source: Statista
16
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
It has been widely noted
that Donald Trump artfully
exploited social media on
his way to the White House.
In France, Germany and the
UK, too, populists are gaining ground through similar
means. In each country, the
respective far-right party
now boasts more Facebook
fans than its mainstream
peers.
As the pace of digitalization
accelerates, that Facebook
fringe will increasingly take
center stage, speaking on
behalf of the working poor
and struggling middle class
threatened by new technology and smart robots.
Today, UK employees earning less than £30,000 a year
are five times more likely to
see their jobs taken over by
machines than those paid
£100,000 annually, according
to Deloitte. That could potentially lead to the creation
of an entirely new under-class
of low-skilled workers.
As the American scholar Warren Bennis famously forecast:
“The factory of the future will
have only two employees,
a man and a dog. The man
will be there to feed the dog.
The dog will be there to keep
the man from touching the
equipment.”
The roles most likely to disappear are those that are
based on repetitive processes, clerical duties and support
services, and in sectors such
as administration, sales, trans-
Clerical roles and support services are at risk
portation, construction, mining, energy and production.
The “safest” jobs, on the
other hand, include those in
computing, engineering and
science. Positions that require creative thought or interpersonal skills – for example, management-level roles
in law, education, healthcare,
media and financial services
– are also likely to prove
more resilient.
The IT sector as a whole
– especially in the US and
Japan – will continue to see
growth, led by robotics and
Internet security. More broadly, business cycles will continue to become shorter and
harder to predict. As a result,
investors will be forced to become even more selective.
It’s worth keeping in mind
that while human employees
will be increasingly replaced
by robots in certain areas,
that will just as surely create
new opportunities – including some that have not yet
even been imagined.
Radical change in the composition of the global workforce is nothing new.
At the beginning of the
20th century, for example,
40% of Americans worked
on farms, compared to just
2% today. One hundred
years from now, it may
seem just as unimaginable
that, back in 2016, more
than half the world toiled
in the service sector, carrying out menial tasks that
any robot could do.
n
17
2017 GLOBAL INVESTMENT OUTLOOK
THE WORLD IN 2017
There are countless reasons to believe the
global economy will continue to expand in
2017. There are also, however, almost as
many reasons to fear that worldwide growth
will stall in the coming 12 months. A look at
the key risks and opportunities
T
he global economy
is at a crossroads.
Although there has
been recent modest improvement, 2017 will mark either
the start of a slowdown or a
slight acceleration. We expect the latter, based on a recovery in industry and energy,
higher consumer spending
and reduced austerity.
Global growth stands at just
over 3% since 2012, well
below historical averages.
The underlying reasons for
sustained sluggishness aren’t
hard to understand: an aging
and shrinking developedmarket population, coupled
with low productivity growth.
Modest growth rates in Europe and the United States
provide cold comfort, as
demonstrated by recent
18
voting patterns there. Indeed, generalized frustration
with the state of the global
economy has led to plenty
of finger pointing – first at
banks, then governments
and cash-rich corporates,
and now central banks and
politicians.
Despite central banks having
established a framework to
enhance economic development, the effectiveness of
such monetary policies has
declined following several
years of near-zero, and even
negative, interest rates.
Central bankers – from
Washington to Frankfurt –
are widely faulted for implementing negative deposit
rates, punishing individual
savers. Given that yields
have been declining for
the last 30 years, however,
monetary authorities should
hardly shoulder all the
blame for the current state
of affairs, including the need
to print money.
More broadly, anemic growth
has led to a backlash against
the forces of globalization,
including current trade and
GLOBAL GDP GROWTH STANDS
AT JUST OVER 3% SINCE 2012,
WELL BELOW HISTORICAL
AVERAGES
immigration policies. In
developed markets, income
inequality is a closely linked
hot-button issue, inspiring
voters in the US Rust Belt
to cast their ballots for
Donald Trump and the
UK’s declining industrial
heartland to overwhelmingly
support Brexit.
In the coming months, as a
number of European nations
head to the polls, we’ll see
just how powerful the forces
of political populism have
truly become.
In emerging markets, of
course, all of this is perceived starkly differently:
economic growth rates are
considerably higher, demographics for most countries
better and middle-income
wealth levels improving at a
far faster pace.
Meanwhile, the digital revolution that has led to displacement in developed markets
– and contributed mightily
to the rise of the developing
world – continues to support
populism’s ascent, particularly
as innovation fuels worldwide
outsourcing trends.
AN UPHILL BATTLE
10-year government bond yields
6
5
4
3
Given that the potential
negative economic impact
of both the Brexit vote and
the Trump election will
not materialize overnight,
European voters may be
highly tempted to likewise
reject the status quo.
2
1
0
-1
2007
2008
2009
Germany
2010
2011
2012
United States
2013
2014
2015
2016
Japan
Source: Bloomberg
19
2017 GLOBAL INVESTMENT OUTLOOK
WHILE THE WORLDWIDE
OUTLOOK IS TENUOUS, WE
EXPECT MODEST GROWTH
AND A GRADUAL RISE
IN INFLATION
Over many years, the increase
in worldwide trade led to a
boost in foreign investment,
greater labor mobility and
overall higher levels of global
growth. In the past few years,
though, the benefits have not
been as visible: as domestic
economies have matured,
growth rates have been less
spectacular.
robotics) suggest the further destruction of jobs, and
even industries. Indeed, the
anticipated digitalization of
the service sector will have
widespread impacts. Similarly, innovation such as 3D
printing will have comparable consequences for freight
and manufacturing industries.
Today, the prospects for digital technologies (including
The rise of e-commerce and
the “sharing economy” – led
Innovation such as 3D printing will impact the manufacturing industry
20
by the likes of Airbnb, Lyft
and Uber – has made it much
more difficult to put a price
on economic output. As the
global economy evolves,
the tools for measuring GDP
(and productivity) need to
keep pace.
Ultimately, the competing
forces of digitalization and
anti-globalization will do
battle in the marketplace
– and in the halls of
government. At this key
moment in history, when
global debt stands at 225%
of GDP, the worldwide
economic outlook is tenuous
and replete with risk.
Overall, though, we expect
modest growth and a gradual
rise in inflation. We already
see some particular potential
opportunities that support
this view.
If Trump proves less an
ideologue than a pragmatist
and does not radically
reshape
existing
trade
agreements, global growth
will get at least a short-term
lift from lower taxes and
increased infrastructure
spending – particularly if
additional countries follow
with
similar
pro-growth
initiatives.
Key fundamentals have also
started improving. Although
debt levels are worrisome,
they are no longer linked
to other securities as they
were in the era of Lehman
Brothers.
Meanwhile, although investments have also decreased
over the last few years, spare
capacity has been reduced
and the outlook for the energy sector has improved –
leading to expectations that
investment will again take off.
Oil prices are far above
their recent lows, wages
are
increasing,
supply
and demand have found
greater balance, consumer
confidence has improved
and
governments
are
more willing to spend.
Consequently, we expect
monetary policy support to
reach peak levels in 2018 and
European tapering to start in
2017, meaning less support
for financial markets.
DEEP IN DEBT
Debt level growth (in %, rebased to 100)
350
300
250
200
150
100
50
2001
2002
2003
2004
2005
United States
2006
2007
2008
2009
Europe
2010
2011
2012
2013
2014
2015
Japan
Source: Bloomberg
The expected recapitalization
of banks, in particular, will be
a game-changer. Research
suggests that an increase in
European banking capital will
improve the global economy
thanks to fortified trust and
more bank loans.
Despite anticipating modest
global growth, there are
alternative 2017 scenarios:
an even sharper increase
in the rate of expansion
thanks to successful growth
initiatives or, on the contrary,
the start of a recession.
While we do not anticipate
the latter scenario, one or
more of the following events
could trigger a serious slowdown: political surprises that
threaten the future of the
eurozone as a bloc, a hard
landing for Chinese debt,
major changes in foreign investment reserves, dramatic
oil-price movement, a lack of
control by central banks and
counterintuitive Trump administration policies.
At a time when the global
economy is at a tipping
point, risks like these could
clearly
jeopardize
the
current growth outlook. n
21
2017 GLOBAL INVESTMENT OUTLOOK
FISCAL & MONETARY POLICY
Most central banks initiated accommodative
policies in the wake of the 2008 financial
crisis. 2017 may finally see a change to such
policy trends
F
ollowing the 2008 financial crisis, government finances in developed markets were left in
tatters.
Confronted with enormous
budget deficits and rapidly
rising debt-to-GDP ratios,
governments were forced
to
revert
to
austerity
programmes to safeguard
creditor confidence in their
long-term ability to service
their debts.
Policy-makers were left with
few options, having to rely
on loose and unorthodox
monetary policies to restimulate
the
economy.
Central
banks
brought
interest rates down to
unprecedented levels and,
in the case of the European
Central Bank (ECB) and
22
the Bank of Japan, even
into
negative
territory.
Meanwhile, all main central
banks
pumped
massive
amounts of liquidity into the
markets by buying billions in
government bonds.
2017, though, may see a
reversal of current policy
trends. Trump’s unexpected election has left markets
struggling to interpret what
the result means for the
global economy. The initial
conclusion is that his proposed mix of tax cuts and
large-scale infrastructure in-
vestment should give the US
economy a much-needed fiscal boost, at least in a short
term.
In addition, the presidentelect is an outspoken
opponent of the Federal
Reserve’s $4.5 trillion balance
sheet, and wants the central
bank to bring it down. If he
gets his way, we can expect a
clear shift in the way stimulus
is carried out – from monetary
to fiscal policy.
Trump’s plans, however, are
clearly inflationary, which
THE ECB COULD BEGIN
TAPERING ITS BOND-BUYING
PROGRAMME IN THE
SECOND HALF OF 2017
would leave the Fed little
choice but to hike rates later
in the year. We expect at
least two rate hikes in 2017.
Unlike their American counterpart, most European governments don’t currently have the
necessary flexibility to engage
markets through fiscal stimulus. In fact, the few European
nations that have ample fiscal
latitude – such as Germany,
the Netherlands and Austria
– are erring on the side of caution and doubling down on
budgetary orthodoxy.
if inflation remains below
its 2% target. Alternatively,
given growing critiques of
the programme, gradual
tapering could start in the
second half of 2017.
In the UK, monetary policy
will be primarily determined
by Brexit negotiations. While
its economy withstood the
shock of the decision to
leave the EU better than
anticipated, the situation
could easily take a turn for
the worse. Although higher
UK rates are not expected,
this is contingent on how
negotiations play out.
Finally, Japan might be the
only G7 nation with declining
rates,
as
the
country
continues to be bogged
down by low inflation. n
FLATLINING
Interest rate indices
6
5
4
3
As a result, the ECB will
have to continue doing all
the heavy lifting. Indeed, we
expect the central bank will
have to keep up its monthly
€80 billion bond-buying
programme – which could
last six months longer than
its March 2017 deadline –
2
1
0
2004
2005
2006
2007
2008
US Federal Funds target rate
2009
2010
2011
2012
Bank of England official Ba
2013
2014
2015
2016
ECB refinancing rate
Source: Bloomberg
23
2017 GLOBAL INVESTMENT OUTLOOK
EUROPE
European growth met expectations in
2016. Over the next 12 months, the pace
of eurozone expansion may slow slightly,
while the UK is likely to see annual growth
slashed in half
2
016 was another solid year for Europe
– marked by roughly
1.5% growth in the eurozone
and nearly 2% expansion
in the UK. While the latter
lagged slightly behind forecasts, not least due to the
June Brexit vote, the eurozone met expectations,
despite countless concerns,
especially on the political
front.
Early economic indicators
suggest potentially similar European growth levels
in 2017. Following Donald
Trump’s election, however,
there is significant uncertainty regarding what his
plans will mean for the old
continent, where the environment, like in the US, has
turned increasingly populist.
24
Europe’s future will therefore
partly hinge on the outcome
of elections in three of the
eurozone’s five largest economies, as well as the ongoing
consequences of Brexit.
On the economic front, both
consumer and corporate
sentiment appear fairly robust. Growth should be further supported by ongoing
strong export demand, especially from Asia, a continued
weak euro and solid private
demand in a range of countries.
That trend is underpinned
by gradually improving labor market conditions, for
example in Spain, Europe’s
fastest-growing major market, and by increasing wages
in Germany, Europe’s largest
economy.
Interest rates (and therefore
financing costs) remain low,
reinforcing the battle against
one of the region’s core
problems: the lack of private
investment. Greater confidence in future development
would be key to improve
capital spending, but the
range of risk factors in 2017
renders this less likely. Further support for Jean-Claude
Juncker’s plan to facilitate
increased European investment – aiming to mobilize at
least €315 billion over three
years – would also certainly
help.
Meanwhile, if Brexit did not
significantly depress UK
growth in the second half of
2016, as many expected, the
consequences will most likely
be felt in 2017. With sterling
weakening, a trend that will
likely run deeper than the 7%
current account deficit, UK
consumers will feel further
negative impacts in the form
of rising prices.
Should Theresa May fulfil her
intention to invoke Article 50
of the EU Treaty by March
2017, her steadfast Brexit
plan will result in political and
economic clashes as soon as
official negotiations begin
with the EU.
Unfortunately for the UK,
sticking to free trade and the
EU banking passport (while
also reworking EU immigration rules) is unrealistic: the
EU will want to avoid other
member states following the
UK’s lead in the case of too
soft an exit. As a result, we
expect UK GDP growth to
decline by roughly half in
2017, falling to just below
1%.
Upcoming elections across
major eurozone countries
also present many potential
risks. As the recent US elections proved, no matter the
predictions, anything could
happen.
In the Netherlands, general
elections in March will likely see an increase for Geert
Wilders’ nationalist, rightwing, anti-immigration and
euroskeptic PVV party from
its current 12 seats in the
House of Representatives.
On the other hand, French
presidential elections in
April/May are not expected to result in the National
Front’s Marine Le Pen becoming president. Instead,
the Republican Party candidate, former Prime Minister
François Fillon, currently
looks more likely to win the
race.
And in Germany’s federal
election in September, the
Bundestag could see six
separate parties win seats
for the first time – with an
ongoing grand coalition
still led by Angela Merkel
appearing to be the most
likely outcome. That said,
the potential of a “red-redgreen” coalition reaching
a majority is very real and
could result in some serious
changes.
While election risk is real in
these countries, and consequently across Europe, it is
unlikely to cause vast changes in 2017.
SLOW AND STEADY
Euro area GDP growth (in %)
3
2
1
0
-1
-2
2011
2012
2013
2014
2015
2016
Source: Bloomberg
25
2017 GLOBAL INVESTMENT OUTLOOK
ITALY REMAINS THE MOST
FRAGILE LARGE EUROZONE
ECONOMY AND WILL
STRUGGLE TO POST
1% GROWTH IN 2017
Meanwhile, risks for Italy –
the most fragile of the eurozone’s larger economies
(not only in politics but also
economics, including banking) – are considerable. Once
again, the country will likely
struggle with annual GDP
growth of under 1%, while
also facing the highest debtto-GDP burden among larger
European countries.
Stagnation in Italy, and potentially elsewhere, is an
issue. Similarly, further structural reforms are also necessary in France. Although the
French economy has recently
benefited from labor-market
reforms, more are needed.
An underlying issue is that
reform in some European
countries, such as France,
has mirrored Europe’s governance problem. For example,
three years ago, the French
26
government set out to boost
its structural household deficit from -1% to +0.5% by
2017. Instead, it fell below
-2% in 2015, and is not expected to see any significant
improvement until 2017. As
usual, though, there were no
consequences for this failure.
Concurrently in Germany,
which is supported by solid consumer and export
demand, there are calls for
further fiscal stimulus. Yet
Finance Minister Wolfgang
Schäuble is unlikely to answer the request by many
countries for Germany to
open its coffers to fund major public investment initiatives.
Nevertheless, increasing
pressure to ease eurozone
savings could result in some
concessions, even if a change
from monetary to fiscal stim-
ulus seems unlikely, despite
support from European Central Bank President Mario
Draghi.
Overall, loose ECB policies –
including ongoing zero/negative interest rate policy and
quantitative easing – support
not only inflation, but also
lending and other economic
trends. Depending on further improvement of these
factors, a tapering process
over the course of 2017 looks
realistic, likely stretching into
2018.
While the ECB can support a
cyclical recovery, it can’t solve
Europe’s structural issues.
The International Monetary
Fund forecasts 1.5% real GDP
growth (adjusted for inflation)
for the eurozone in 2017. We
expect this figure to be closer
to 1.3%.
That said, Europe’s economic, political and social environment is fragile
and replete with potential
risks, which could lead to
downward revisions during
the course of 2017.
n
THE UNITED STATES
The expansion of the American economy will
continue in 2017, with GDP growth reaching
2.4%. Trump administration policies should
also prove supportive – unless, of course, the
incoming president starts a global trade war
T
he economic outlook
for the United States
has continued to improve since the summer, with
wage growth and recovery
of the industrial and energy
sectors supporting already
positive fundamentals. In the
third quarter, the economy
expanded by 2.9%, its fastest
pace in two years, as exports
surged and inventory investment rebounded.
So while today’s cycle is
unusually long, the recovery
has, until now, also been
unusually
shallow,
partly
due to structural factors
such as demographics and
productivity. Consequently,
we
expect
growth
to
be sustained and even
accelerate, reaching 2.4% in
2017, up from some 1.6% in
2016.
In January 2017, the United
States will inaugurate its
most avowedly protectionist
LET’S GO SHOPPING
US personal consumption expenditure (in USD)
13000
The current upward cycle
started in early 2009, already
lasting longer than the
historical norm – excluding
the periods of sustained
growth that commenced in
1969 and 2001. Keep in mind,
though, that the rate of real
GDP growth, adjusted for
inflation, has remained below
average since the end of the
Great Recession.
12500
12000
11500
11000
10500
10000
9500
9000
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Source: Bloomberg
27
2017 GLOBAL INVESTMENT OUTLOOK
president
since
Herbert
Hoover. Hoover, who held
office from 1929-33, approved
the notorious Smoot-Hawley
Act that raised US tariffs on
some 20,000 categories of
imported goods, sparking
a global trade war and
contributing to the severity of
the Great Depression.
Of course, Trump (who has
never held political office)
may prove to be no Hoover.
Importantly, while he has
roundly criticized existing freetrade agreements, especially
BETTER EMPLOYMENT
RATES AND HIGHER WAGES
WILL SUPPORT INCREASED US
CONSUMER CONFIDENCE
NAFTA – and lauded the
UK’s Brexit vote, which he
called a “great victory” –
Trump is more likely to seek
to renegotiate such deals
than scrap them wholesale.
Likewise, campaign rhetoric
about China and Mexico
(where the promised wall has
already been downgraded to
Deals like NAFTA could be renegotiated, but not scrapped wholesale
28
a fence) is unlikely to lead to a
complete dismantling of such
vital trade relationships.
Despite Republican majorities
in both the House and Senate,
Trump can’t act in most
areas without congressional
approval.
Consequently,
he’s likely to prove less
radical than many fear. For
the same reason, Trump will
be better positioned than
his predecessor to enact
pro-growth policies such
as increased infrastructure
investment.
In any case, the short-term
outlook for the US is already
improving. In 2015 and 2016,
capital expenditures related
to energy were a drag on
investments, but that is
unlikely to be repeated in
2017. Furthermore, trends in
labor markets, bank lending,
industry and services all point
toward ongoing expansion.
In 2016, consumer spending
increased and is likely to remain healthy. Better employment rates, higher wages,
lower debt levels, wealth
gains and fewer underwater
homeowners will support
increased consumer confidence and spending.
For corporate America,
however, there is a risk that
wage growth will accelerate
as labor markets already
show some scarcity. Together with rising interest costs,
profit margins could be under pressure. Sales growth
and lower corporate taxes,
however, could more than
compensate for this negative impact.
The Trump administration
is likely to prioritize tax reform, infrastructure investment and defense spending,
which would support midterm growth. Meanwhile, the
repatriation of foreign profits could lead to increased
domestic reinvestment as
well as higher tax receipts.
Trade barriers, restrictive immigration policy and rising
If the Trump administration
ignores budgets and debts
or implements trade barriers
that lead to imported
inflation, additional hikes
can be expected.
Historically, the average increase during a tightening
period amounts to more
than 400 basis points, which
is unlikely given weaker
growth and inflation. Moreover, this comparison ignores the impact of the earlier quantitative easing on real
yields. We expect the Fed to
pre-commit to the rewinding
of its bond portfolio, taking
market reaction into account
in this decision.
budget deficits, on the other hand, would hit growth
and, most likely, overall
sentiment. Anyway, Trump’s
“America First” vision will
be difficult to realize as comparable reshoring initiatives
have lost ground since the
dollar strengthened.
To combat inflation and
return to more normalized
monetary policy, we expect
the Federal Reserve to hike
rates at least twice in 2017.
Trump, who has described
himself as “a low-interest-rate person,” has already said that he will replace the Fed’s chairwoman,
Janet Yellen, at the end of
her term in 2018 as he prefers a more rule-based policy. Whatever happens between now and then, Yellen
almost surely won’t resign,
which would damage the
Fed’s perceived independence and credibility.
n
29
2017 GLOBAL INVESTMENT OUTLOOK
JAPAN
Shinzo Abe and the Bank of Japan have
seen some success in improving the
country’s economic competitiveness.
Unfortunately, though, demographics
will continue to weigh heavily on
Japan’s longer-term outlook
J
apan’s
demographic
challenge is, of course,
still the key issue for the
nation’s future. With an aging
and shrinking citizenry, the
working-age population continues to decrease, putting
attendant stress on the country’s already fragile economy.
Consequently,
economic
growth rates will remain low,
which is why Prime Minister
Shinzo Abe’s efforts to mitigate the population issue
are very important. As the
labor-force participation rate
approaches its limit, the government is actively seeking to
attract more foreign workers,
with a particular focus on IT.
In fact, the number of foreign
workers is expected to expand 10% annually until 2025.
While tax breaks are expect-
30
ed in order to stimulate new
industries, Japan’s surprising
lack of high-tech tools to
measure GDP has left its systems wanting – preliminary
data collection often requires
drastic revision.
Nevertheless, we expect
GDP growth to reach 1.2% in
2017, an increase of roughly
0.6% from 2016. Roughly half
of this increase is due to government spending: in August
2016, Abe’s cabinet launched
a $45 billion multi-year fiscal
stimulus package.
Domestic demand is likely to
increase as wages improve
and food prices stabilize.
Additionally, negative interest rates have inspired a
recovery in durable goods
consumption and home purchases. The Bank of Japan
(BoJ) is doing what it can to
galvanize the economy, but
this is no easy task. Monetary support, for example, is
dwindling.
With the BoJ’s recent policy
“regime shift” from a focus
on base money to yieldcurve targeting, we expect
the central bank to taper its
¥80 trillion purchase pace in
2017. This change, though,
is hardly symbiotic with Japan’s quantitative easing
programme. If yields are below target, the BoJ could be
forced to stop purchasing
bonds or even to sell them.
All in all, growth rates for
Japan will remain low, as its
declining population continues to counter-balance
any
significant
economic progress.
n
CHINA
China’s economy may be in transition – shifting from industry to
services – but growth levels remain robust. A look at the key items
on the country’s reform agenda
A
s the world’s largest
fast-developing
economy,
China’s
economic,
political
and
social developments must be
watched very carefully. After
all, the cliché was never truer
than here: If China sneezes,
the rest of the world will
catch a cold.
China is today in transition,
as it has been for some time
and will remain so far into the
future. Shifting away from a
heavily industry-dependent
and export-led economy is
no small task. Simultaneously
building a services-based
and consumer-led system
will take time and not
occur without considerable
turbulence.
by domestic investors going “all-in” for real estate.
As a consequence, there
has been a curb on property
loans and purchases.
Meanwhile, corporate debt
has skyrocketed, forcing
Beijing to apply stop-and-go
policies and strict measures
on
specific
companies;
interestingly, these have
for strategically
corporates.
important
Even as China tackles
overcapacity, its economy
nevertheless continues to
expand, recording 6.7%
growth in the first nine
months of 2016.
Notably, the yuan has
achieved the status of inter-
China must address its potential property bubble
Chinese leaders are focused
on erasing certain imbalances in the economy, including too much debt and a
potential property bubble.
The latter has become an
increasingly pressing issue
due to a decline in the Chinese stock market and has
been further exacerbated
been aimed mainly at stateowned enterprises.
Although corporate China
faces high debt levels, the
Central Government does
not share this predicament
and could become the lender
of last resort, as it already is
national reserve currency,
becoming part of the International Monetary Fund’s
special drawing rights basket.
That’s one more tangible
sign of the increasing importance of China to the
overall global outlook.
n
31
2017 GLOBAL INVESTMENT OUTLOOK
EMERGING MARKETS
After years of stagnation and decline, the
outlook for emerging markets has finally
turned the corner. But how long will the
good times last?
I
n 2016, emerging market
(EM) equities outperformed – and for good
reason.
ing EM countries require to
improve the supply side and,
more generally, reduce bottlenecks.
Most emerging economies
are enjoying steady growth,
while market imbalances are
diminishing, as shown by
narrowing current account
deficits. Although not all
emerging markets are the
same – some face dire
situations as their economies
slide – the general outlook
should
become
even
brighter in 2017.
On the international trade
front, markets such as
South Korea and Taiwan,
long considered “canaries
in the coal mine,” have
been
showing
rising
export volumes. However,
China, by far Asia’s biggest
exporter, has suffered from
soft global demand, with
exports falling most of the
year.
Average inflation rates are
declining. As a result, most
central banks are considering rate cuts. Lower rates
would support additional
investment, facilitating the
kind of infrastructure spend-
32
Meanwhile, in Latin America, the gradual commodity
price recovery has proved
a blessing. Ongoing reform
in countries like Argentina,
Brazil, Colombia and Peru
is further contributing to
increased investor confidence.
Of course, the current recovery has come from a low
base. Brazil is still not seeing
expansion but is at least approaching it. The corporate
earnings cycle is also turning
upwards.
EMERGING ECONOMIES ARE
MOSTLY ENJOYING STEADY
GROWTH, WHILE
MARKET IMBALANCES
ARE DIMINISHING
ing developed markets over
that period. Today, EM assets remain well positioned.
A BRIGHT OUTLOOK
Purchasing manager indices
60
For the first time in years,
however, the balance outlook for emerging markets is
positive.
58
56
54
52
50
16
16
20
/0
9/
16
20
7/
/0
30
16
20
5/
/0
31
16
20
3/
/0
31
15
20
1/
/0
31
15
20
1/
/1
31
15
20
9/
/0
US economy weighted manufacturing
30
15
20
7/
/0
30
15
20
5/
/0
31
31
15
20
31
/0
3/
14
20
31
/0
1/
14
20
30
/1
1/
14
20
30
/0
9/
14
20
31
/0
7/
14
20
31
/0
5/
14
20
3/
31
/0
20
1/
1/
/1
/0
20
13
48
30
Of particular note, EM purchasing managers indices
(indicators of the health of
the manufacturing sector)
showed especially positive trends over the middle
months of 2016, outperform-
versus most EM currencies,
emerging-market
assets
could, once again, return
to sustained declines. And
if that happens, overseas
investors are likely to
quickly cash out and return
home. Only time will tell. n
This trend may well continue,
but investors must keep a
close eye on the US dollar.
If the greenback rallies
31
Elsewhere, political instability in South Africa continues
to scare away foreign investment. The same can be seen
in Turkey, where the regime
has become increasingly autocratic and a severe current
account deficit is coupled
with scarce Forex resources.
Consequently, the country’s
economic future appears
uncertain.
EU composite PMI output
Emerging markets composite
Source: Bloomberg
33
2017 GLOBAL INVESTMENT OUTLOOK
EQUITIES
Digitalization,
coupled
with
increasing
interconnectivity, continues to reshape the
worldwide business landscape – and the
outlook for equities. A look at key global
equity markets
T
oday,
traditional
business models are
under strain and at
risk of significant disruption.
They are being overtaken
by powerful new models,
driven by digitalization, that
are proving more agile and,
ultimately, more profitable.
Consider
34
Walmart,
one
of the world’s largest
companies, with some $500
billion in annual revenues.
The firm’s historical success
is based on its promise
of “everyday low prices,”
which it has achieved
through ruthless supplychain
management,
including by encouraging
American manufacturers to
push production to lowercost locations overseas.
Walmart is one of globalization’s success stories –
but may prove to be one of
digitalization’s losers. Compared to Amazon, which
generates $100 billion in
annual e-commerce sales,
Walmart is an also-ran, with
just $15 billion in annual online sales.
It’s
no
surprise
that
investors continue to bet
big on Amazon, while
mostly sitting tight on
Walmart. That includes
Warren Buffett, who is
rapidly cashing out of the
Arkansas-based retailer.
Among their distinguishing
characteristics, one thing
today’s digitalized leaders
tend to have in common is
their asset-light approach:
Amazon’s inventory is just
a fraction of that of its bigbox peers; Facebook, unlike
the New York Times, doesn’t
hire foreign correspondents;
Uber is beating taxi firms
at their own game without
buying a single car, let alone
a fleet; and Airbnb, which
threatens to take over the
global hospitality business,
has never changed a sheet.
All
of
these
“young”
businesses are based on
entirely new models. Which
leads to the question: What
35
2017 GLOBAL INVESTMENT OUTLOOK
Today, however, the old
economy is primarily
composed of traditional
business
models;
when
you buy the whole market,
you are mainly exposed
to them. That’s why, while
we remain constructive on
equity markets, we focus
on preferred sectors, subsectors and styles.
OVERLY INFLATED?
Global equity indices
210
190
170
150
130
110
90
70
50
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
S&P 500
STOXX 600
Nikkei 225
Source: Bloomberg
impact will this continue to
have on equity markets?
The rise of digitalization and
the consequent changes
to current models remain
unpredictable, and have
made investing in US equity
markets,
in
particular,
especially complicated. The
rise of populist sentiment
there,
embodied
by
incoming President Donald
Trump, has fostered further
uncertainty.
Buying an index like the S&P
500 may provide exposure
36
to the buoyant part of the
economy, but equity markets
are still overly inflated with
traditional business models.
The impact is clear: US
stocks trading at alltime highs, with slightly
expensive valuations and
margins that are beginning
to rise again.
Meanwhile, ongoing advances in new technology
could prove especially supportive of US IT firms, powered by disruptive business
models.
In the US, given Trump’s
expected
emphasis
on
i n c re a s e d g o v e r n m e n t
spending
and
reduced
individual and corporate tax
rates, we expect to see higher
budget deficits, inflation and,
finally, bond yields. This will
have a major impact on sector
and style rotation.
Of particular note, Trump
has said that he will slash the
current corporate tax rate
of 35% to just 15%, while
simultaneously broadening
the base of firms eligible
for what would be among
the world’s lowest rates,
supporting US reshoring.
If
ratified,
this
could
significantly boost earnings
per share estimates for firms
in a range of sectors.
IN EUROPE, WE FAVOR
VALUE-ORIENTED STOCKS
AND MORE CYCLICAL SECTORS,
SUCH AS MATERIALS
AND INDUSTRIALS
More broadly, current trends
suggest that companies
with a strong domestic
foundation
have
better
prospects than those that are
dependent on international
trade or overseas profits.
Additional infrastructure
investment is likely to
support construction, while
defense, energy, mining,
pharmaceuticals and
insurance should also benefit
from Trump’s election.
middle ground between
top-down and bottom-up
approaches leads us to favor
value-oriented stocks and
more cyclical sectors, such as
materials and industrials.
This view is based on positive
commodity
price
trends, slightly rising infla-
tion, genuine base effects
and improving consumption
indicators.
At the same time, the yield
curve
should
steepen,
bringing
some
positive
effects on bank and insurance
stocks, though operating
profits remain fragile. The
steepening curve will also
push sectoral rotation away
from defensive, crowded
and expensive plays into
higher-value, and higherrisk, sectors.
Finally, as monetary policy
US financial shares have
already recorded significant
gains since Trump’s election.
It remains to be seen if
further outperformance will
be recorded in 2017.
Likely losers include renewable energy, exporters, consumer staples and healthcare services.
In Europe, meanwhile, the
Trump’s election is bad news for the renewable energy sector
37
2017 GLOBAL INVESTMENT OUTLOOK
THE INTRODUCTION OF
A NATIONWIDE GOODS
AND SERVICES TAX WILL
HELP UNIFY INDIA’S
VAST DOMESTIC MARKET
proves
an
increasingly
ineffective tool to support
the economy, there is a
clear need for fiscal policy to
stimulate investment.
All of this supports our
strong preference for more
cyclical commodity-oriented
segments at the expense of
defensive sectors.
Following
another
difficult
year for Japanese equities –
despite ongoing strong central
bank support – the Tokyo
Stock Exchange will likely
face continued challenges.
Given
moderate
growth
and lackluster company and
consumer sentiment, there
seems to be limited reason
for confidence in Japanese
stocks, although companies
are becoming more efficient
and commercially focused.
Recovering commodity prices will support countries like Brazil and Russia
38
That said, when it comes
to valuations, the TOPIX is
most attractive based on
multiples and risk premia.
With ongoing support from
the Bank of Japan, continued
pension fund investments
and potentially increased
buying
by
cash-rich
households, earnings growth
is likely to reach mid-to-high
single digits in 2017.
Overall, we take a neutral
stance on Japanese equities.
Despite
an
increasingly
bright macroeconomic outlook, our position on emerg-
ing-market (EM) equities is
also neutral, reflecting the
very heterogeneous nature
of this market.
Nevertheless, in most EM
regions,
positive
trends
– including more stable
currencies – are mirrored
by solid sentiment data and
higher import demand, likely
enabling double-digit growth
in earnings per share in 2017.
However, ongoing US dollar
strengthening and rising
US rates could continue to
burden EM assets.
The gradual commodity price
recovery – including upward
trending oil and copper
prices – should remain
supportive of commodityexporting countries like Brazil
and Russia. But considerable
risks remain in both broader
regions.
Despite
the
need
to
address current imbalances,
including too much debt,
China continues to appear
capable of managing its
soft landing. Trump’s threat
to start a trade war with
the world’s most-populous
BACK ON TRACK?
MSCI Emerging Markets Index
500
450
400
350
300
250
200
150
100
50
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Bloomberg
MSCI EM
nation has introduced a
major new risk factor, though
it may prove to be mostly
hot air.
slightly positive performance.
We expect equity markets
to rise, on balance, by midsingle digits.
Meanwhile, the upcoming
introduction of a nationwide
goods and services tax
will help unify India’s vast
domestic market, one of the
brightest spots in emerging
Asia.
However, potential risks
include a possible bondmarket crash, further
dissolution of the EU
and
abundant
political
turbulence (again,
particularly in Europe).
Globally, it’s unlikely that 2017
will prove an outstanding
year
for
equities,
but
sufficient liquidity and the
lack of obvious alternatives
will nevertheless support
Given such event risk and the
ongoing rise of digitalization,
expect continued disruption
to old models in 2017 –
and, most likely, significant
volatility in the market. n
39
2017 GLOBAL INVESTMENT OUTLOOK
FIXED INCOME
Given the highly volatile environment,
bondholders should brace themselves for a
challenging 2017, when Trumpenomics
will almost surely lead to rising yields
W
ith official interest rates at alltime lows and
most major central banks
engaged in bond-buying
programmes, market rates
also plunged in the course
of 2016. In the wake of the
Brexit vote, for example, 10year German bond yields fell
into negative territory. Even
more dramatically, Swiss
government yields – all the
way up to 50 years – quoted
at negative rates.
Desperate investors tried to
escape negative yields by
taking on more credit risk
in corporate and high-yield
bonds, driving down the
spread on these assets in
the process. In Europe, the
move towards lower credit
spreads was reinforced by
the European Central Bank
(ECB) starting to buy corporate bonds as part of its
bond-buying programme.
From June onwards, the
ECB bought about €10
billion per month in corporate paper. Investors
thus perceived corporate
bonds as a one-way bet,
dipping into them with
more enthusiasm.
WHILE THE US WILL FACE
RISING RATES IN 2017,
EUROPE IS LIKELY TO SEE
BOND-BUYING TAPERING
IN THE SECOND HALF
40
These actions drove the
additional yield on corporate bonds down to very
low levels: some well-rated
companies were even paid
to borrow, as they could sell
bonds at negative yields.
Emerging markets, too, saw
decent inflows as yield-hungry investors returned to
regions they had avoided
for years.
2017 could prove to be a
whole lot harder for bondholders.
In the United States, rates
are expected to rise further
under the Trump administration. On the other side of
the Atlantic, the market will
have to deal with the prospect of the ECB bond-buying tapering in the second
half of the year. As well,
expected higher inflation
numbers – which will rise as
the effect of lower oil prices starts to drop out of the
year-on-year comparison –
will also push up yields. So
markets could be in for a
difficult year indeed.
As investors start to identify better-yielding alternatives in safer government
paper, they might think
twice before adding to
their already considerable
positions in more risky
credit – so there’s little
hope the segment will outperform.
Emerging markets may
also face a volatile year,
particularly given the possible impact of a Trump
presidency on international trade relations, which
led to a sharp sell-off in
November.
A MIXED MARKET
High-yield credit spreads, by currency
1100
1000
900
800
700
600
500
400
300
200
2010
2011
USD high yield
Source: Bloomberg
2012
2013
2014
EUR high yield
2015
2016
GBP high yield
We remain constructive
on this segment, however,
as improved governance,
stronger domestic economies and ample currency
reserves partially shield
emerging markets from
the fallout of potentially
deteriorating export performance.
n
41
2017 GLOBAL INVESTMENT OUTLOOK
NON-TRADITIONAL
ASSET CLASSES
At a time when interest rates have reached
unprecedented lows, investors increasingly
see equities as their only option. However,
they should also consider the diversification
benefits of alternative strategies
I
n a low-interest rate
world, where bonds
hold limited appeal,
most investors are understandably venturing further
into equities – a trend that
could put at risk the longstanding strategy of diversification between bonds
and equities.
At the same time, if yields
witness a sharp increase,
some investors will be
tempted to move back
to the bond market. That
could set off a troubling
chain reaction.
Higher yields would then
trigger a selloff in the bond
market, while the resulting outflows would lead to
the same in equities. There
would then be no diversification benefit between those
two asset classes.
Cue alternative investments.
Their limited correlation
to traditional asset classes
makes them very attractive
in this volatile environment.
Investing a portion of a diversified portfolio in a combination of absolute-return
strategies would likely help
OUR PREFERRED STRATEGIES
INCLUDE EQUITY-MARKET
NEUTRAL, MERGER ARBITRAGE
AND ABSOLUTE-RETURN
BOND STRATEGIES
42
investors navigate potentially
troubled waters.
We prefer funds that are
largely delinked from both
equity and bond markets.
Our currently preferred
strategies are equity-market
neutral, merger arbitrage
and absolute-return bond
strategies. We also see opportunities in private equity
and, in particular, mid-cap
buyout and infrastructure
funds.
An equity-market neutral
strategy removes any directionality to the market.
For every dollar invested
long on one stock, there is
a dollar invested short on
another. Thus, the return
on this type of strategy will
be driven by the differential between the stock held
long and the one held short,
regardless of a sector’s performance.
Merger arbitrage funds, on
the other hand, focus on
an environment in which financing is cheap and readily supporting high levels
of M&A. Merger arbitrage
specialists seek to capture
the difference between the
share price of a company
and the price offered by its
acquirer by buying the stock
of the target company at a
discount to the acquisition
price.
The profit is in the risk the
deal will not close on time,
or at all. Because of this uncertainty, the target company’s stock will sell at a discount. If and when this deal
is approved, though, the two
stock prices will converge,
returning a profit on the discounted stock.
The obvious risk is that if a
deal breaks down, the share
prices plummet. This challenge can be mitigated, however, by diversifying a portfolio among a large number of
deals – which is easy to do in
today’s merger-friendly environment.
Absolute-return bond strategies seek to benefit from
THE RETURN OF M&A
Global deal count
45000
40000
35000
30000
25000
2005
2006
Source: Bloomberg
2007
2008
2009
2010
2011
2012
2013
2014
2015
mispricing in the bond market by applying a combination of macroeconomic, microeconomic and technical
analysis. They usually invest
long and short in a wide
range of bonds, from government to corporates, both
from developed and emerging markets. Some managers also use currencies to
enhance returns or manage
portfolio risk, with potentially zero to negative sensitivity
to interest rates.
Absolute-return bond strategies will be able to benefit
from the amplified mispricing
in the bond market if yields
continue to rise.
Finally, we are positive on
private equity as an asset class. In particular, we
see opportunities in midcap buyout funds, which
continue to offer the best
risk-return
relationship
among all buy-out funds,
and infrastructure funds,
which should benefit from
anticipated increased US
and European infrastructure investment and fiscal
stimulus.
n
43
2017 GLOBAL INVESTMENT OUTLOOK
COMMODITIES
The world’s worst-performing asset class
in 2015, commodities are finally trending
upwards. What’s driving this positive trend?
F
ollowing five years of
steady commodity price
declines and significant
industry consolidation, there
are now signs that the cycle is
starting to turn. Indeed, thanks
to greater supply-demand
equilibrium, the price outlook
for 2017 is favorable.
What’s driving this positive
trend?
First, manufacturing activity
is improving in both
developed and emerging
markets, especially in Asia.
Second, central banks seem
to have nearly exhausted
the possibilities offered by
accommodative monetary
policies. Hence, they are
pressing governments to use
fiscal leverage and increase
infrastructure spending.
These developments are
44
favorable for the demand side
of the equation.
Simultaneously, on the supply
side, producers appear more open to capping
output. OPEC producers, for
example, are aiming to push
oil prices higher through
production limitations. Although surprises could still
arise during the year-end
quota discussions, markets
have already reacted with a
nice price rebound.
Oil is also a major contributor to the production cost of
commodities such as metals
and agricultural products, so
we forecast a general uptrend
for the whole asset class. Industrial metal prices will also
be pushed higher by production cuts resulting from
earlier reductions in capital
spending by mining companies. Meanwhile, Chinese
steel mills (which account for
half of global output) are also
finally reducing production.
Risks to the current recovery
nevertheless still exist. A
major slowdown in China’s
property market, in particular,
would lead to a significant
reduction in demand for
construction materials and
other commodities.
O v e r a l l , h o w e v e r, t h e
balance between supply
and demand – further supported by increased investment flows – should prove
even more favorable for
producers in 2017. Consequently, investing in commodities should offer diversification benefits as part of a
balanced portfolio.
n
CURRENCIES
While the outlook is neutral for the US dollar, sterling will face
strong headwinds in 2017. Meanwhile, commodity-linked
currencies should recover
E
xamining the world’s
major currencies, we
remain broadly neutral
on the US dollar for a euro investor. Positive euro currency
account fundamentals have
offset tightening by the US
Federal Reserve, driving an
increase in US yields.
Meanwhile, the Japanese
yen is also supported by
relatively
strong
current
account fundamentals that
attract particular support
in times of elevated risk
aversion.
However,
more
recent
weakening of the yen –
as the USD rallied on the
back of Donald Trump’s
surprise election – makes
a breakthrough for the
Japanese
currency
look
somewhat less likely.
In the UK, by comparison,
the support of a solid current
account surplus is entirely
absent and, understandably,
this weighs heavily on
sterling.
The pound is struggling
against a headwind of
u n c e r t a i n t i e s re s u l t i n g
from the UK’s impending
departure from the EU. As a
result, expected macro and
political developments look
set to have an enormous
effect on the currency and,
for the most part, we remain
negative about its outlook.
Barring emerging-market
currencies that are distracted by domestic issues (such
as the South African rand
and the Turkish lira), commodity-linked and emerging
currencies should remain
supported. However, this is
predicated on the assumption that Fed tightening will
be very gradual.
Meanwhile, the stabilization
of commodity prices has
provided a significant boost
to commodity-linked currencies. We expect 2017 to be
positive for them, with support coming from ongoing
robustness in China.
At the end of the day, it is
the outlook for the massive
Chinese economy – and
its impact on the rest of
the world – that continues
to represent the single
biggest risk factor to our
currency forecasts.
n
45
2017 GLOBAL INVESTMENT OUTLOOK
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2017 GLOBAL INVESTMENT OUTLOOK
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48