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Different world
The past year has been one of surprises and uncertainty
but as Paul O’Connor, Head of Multi-Asset at Henderson,
explains, understanding the themes at work can allow
investors to weather the change in global conditions
Heather Farmbrough, Editor, Citywire
A
s 2017 unfolds, we have a new US
President who is very different from his
predecessors, particularly in terms of trade
and international relations; a White Paper
arriving shortly on Brexit; and elections in the
Netherlands, France and Germany, each in
the face of rising national populism.
These fresh political concerns come at a time
when the world is already attempting to deal
with Russian belligerence, an unpredictable
North Korea and an unstable Middle East.
And yet, over the last few months, equities
have been reaching record highs in several
markets as investor faith in ‘reflationary
stimulus’ has eclipsed other concerns.
For Paul O’Connor, Head of Multi-Asset
at Henderson, the return of politics is one
of the key themes driving financial markets,
and he believes investors will need to be
particularly careful with their asset allocation
this year. He has factored the following
into his outlook for assets in 2017: Brexit
risks, rising protectionism and what he aptly
refers to as “Trump-specific negatives”.
Along with more politics, O’Connor
has identified two other themes for
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Along with more politics, O’Connor has identified
two other themes for investment in 2017:
more growth and more inflation
investment in 2017: more growth and
more inflation. His view is underpinned by
expected global growth of 3-3.5 per cent and
inflation of around 2 per cent in developed
economies.
This is a very different scenario from recent
years. “The post-crisis world was defined by
tight fiscal (government budgeting) policy and
easy monetary policy”, he says. “Markets were
priced for sustained deflation or low inflation.
This, combined with austerity measures,
was a very beneficial environment for
government bonds.
"In the second half of 2016, however,
financial markets recognised that we had
reached the end of the great phase of
monetary easing – although Japan was still
doing its last bit of quantitative easing – and
that we were moving into an era of fiscal
easing. Government bonds began to look less
attractive while equities became more so.”
O’Connor is sanguine about the outlook.
“Economies are doing ok, growth across the
top 20 economies of the developed world
is steady, inflation is pretty normal, and the
world recovery is broadening out. The global
economy is resilient.”
As a multi-asset manager, O’Connor takes
a macro look at both regions and different types
of assets before deciding how much to invest
in equities, fixed interest and alternatives. Which
comes first? Regions or asset classes?
“Sometimes it’s all about the region; the
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region can dominate our asset selection,”
he replies. “For instance, in 2012-14,
when the commodity bubble collapsed as
markets adjusted to the slowdown in growth
in China, there was a big growth hole in
underdeveloped markets.”
At the time, regional considerations came
before asset selection. Indeed, O’Connor
explains, “For much of the time after the
financial crisis until Autumn 2015, our
portfolios were quite stylised in terms of
regional exposures – we were underweight
in emerging markets and angled towards
those regions experiencing powerful
quantitative easing.”
After that, he and his team began to invest
more heavily in emerging markets as weak
commodity prices and concerns about China
allowed them to exploit a value window.
The appointment of Donald Trump, however,
heralded concerns about the impact of
increased US protectionism on free trade,
about which O’Connor was initially concerned
so he took a slightly more neutral position on
emerging markets. He believes that markets
Sometimes
it’s all about the
region; the region
can dominate our
asset selection
have now factored in the increasingly
domestic-oriented nature of US policy.
Regardless of Trump, with monetary
policy now looking tired around the world, the
Multi-Asset Team believes that growth, rather
than central banks, is becoming the key
factor driving asset allocation.
“We continue to favour assets that can
benefit from stronger growth and are resilient
to the withdrawal of central bank liquidity,”
says O’Connor. “Accordingly, equities remain
our favourite asset class while we are neutral
on credit and remain wary of government
bonds.”
Political considerations and sentiment are
likely to continue influencing investment
decisions. This sort of environment creates
the chance to trade – last year, the team
responded to the election of Trump and the
Brexit result by de-risking, while O’Connor
is now looking for opportunities to rebuild
the fund’s exposure to emerging markets.
With a multi-asset portfolio characteristically
allowing plenty of options, O’Connor is calmly
confident about 2017. 
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us inflation
6
uk inflation
CPI y-o-y % change US Federal Reserve Funds Target Rate %
CPI y-o-y % change 10-Year UK Gilt Yield %
2.5
5
2
4
3
1.5
2
1
1
0
0.5
-1
0
-2
-3
-0.5
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters Eikon. Bureau of Labour Statistics, non seasonally adjusted
Consumer Prices Index (CPI), year-on-year percentage change, and US Federal Reserve
Funds Target Rate, from 31 Jan 2006 to 31 Dec 2016.
2015
2016
Source: Thomson Reuters Eikon. Office for National Statistics, non seasonally adjusted
CPI, year-on-year percentage change, and UK 10-Year Gilt Yield (redemption yield).
Data from 31 Jan 2015 to 31 Dec 2016.
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What are the main challenges
for the global economy this year?
The main near-term challenge is rising
inflation, which reflects a strong economy
– much stronger than expected by
the consensus six months ago – and
associated upward pressure on commodity
prices. Inflation concerns will be further
heightened if the Trump administration
introduces significant protectionist
measures or succeeds in pushing through
a large fiscal stimulus package. Rising
inflation will squeeze real monetary growth
and is likely to prompt other major central
banks to follow the Federal Reserve in
withdrawing policy stimulus – such a
tightening of liquidity conditions would
pose a threat to markets.
IN CONTEXT
Economist Simon Ward
on the main challenge
for the world economy
in 2017, and likely
areas for optimism
How significant is inflation
to your outlook?
Global core consumer price inflation –
excluding food and energy prices – has
been remarkably stable in recent decades,
with swings in headline inflation driven by
strength or weakness in commodity prices.
A key issue for 2017 is whether faster
growth and tight labour markets in many
economies will push core inflation higher,
forcing central banks to tighten policies
more aggressively. Our central scenario is
that a recent decline in global real money
growth will be reflected in an economic
slowdown during the second half of 2017,
reducing the risk of core inflation breaking
out.
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On the upside
Which areas give rise
to optimism?
The Chinese and Eurozone economies
may surprise positively. China pessimists
worry that the economy will slow as
fiscal support fades, but monetary trends
remain solid and corporate profits have
rebounded strongly, promising a pick-up
in business investment and stockbuilding.
Rising interest rates, meanwhile, may slow
capital outflows and support the currency
– unless President Trump imposes tariffs.
In the Eurozone, the German and
Spanish economies remain strong
and there have been brighter signs
recently in France and even Italy.
Eurozone-wide unemployment
continues to decline steadily but
there is more economic slack than
in other regions, suggesting lower
inflation risk.
Simon Ward is Henderson’s Chief
Economist. He has worked as an
economist studying financial markets
for more than 25 years. He believes that
changes in monetary conditions are a
key driver of both the economic cycle
and movements in financial markets;
accordingly, a forecasting approach
emphasising monetary analysis has
a better chance of success. 
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