"Some investors have quipped that it took days for the markets to digest the UK referendum outcome, hours to come to terms with Donald Trump as President-Elect and minutes to assess Italian Prime Minister Matteo Renzi’s resignation,” Mark Haefele, global chief investment officer at UBS Wealth Management, told clients last week.
It has been a year defined by political risk and volatility, but investors have stayed optimistic and many will have reason to celebrate. The S&P 500 has risen more than 10 per cent since January. The FTSE 100 has gained almost 15 per cent – even the more domestically focused FTSE 250 has risen 5 per cent. Emerging markets have done better still.
“Yet,” Haefele adds, “we will only develop a truer sense of how these political changes affect real economic outcomes over the course of the next year.” So how good has 2016 really been?
Brexit and UK equities
The shock from the Brexit vote was acute, and undoubtedly deterred many from entering the market. “Net sales of investment funds look set to be sharply down on the previous year,” writes Jason Hollands of Tilney Bestinvest. But sticking with equities has paid off for those who kept their nerve. “In local currency terms, UK equities have been the best performing developed market despite the diet of gloomy predictions around Brexit or the consistent pattern of UK equities being ditched by retail investors,” Hollands added.
Read more: Why investors shouldn’t fear Brexit
The big rises in blue-chip UK equities since June have largely been driven by a 15 per cent fall in the trade-weighted value of sterling. Fully 70 per cent of FTSE 100 earnings come from abroad, and their returns have been flattered when converted back into pounds. Attracted by strong earnings and cheaper relative share prices, foreign buyers have poured in, pushing the index to a record high. “Sterling fell after Brexit, and that saved us really,” says Michelle McGrade, chief investment officer at TD Direct Investing.
But a weaker pound has exaggerated the returns Brits have made on other stock markets. Sterling investors have made a massive 20.7 per cent gain from the Japanese Topix index this year, for example. But the total return in local currency terms is -3 per cent, Hollands points out. The same phenomenon can be seen with European equities.
However, the yen and the euro have fallen against the pound in recent weeks – a trend which ETF Securities predicts could continue in 2017. Currency movements could yet swallow the gains made through overseas investments by Brits this year.
Read more: Brexit and sterling? It's no biggy for Numis
On the other hand, if the Fed raises rates more aggressively next year, the dollar may strengthen further, tarnishing the appeal of large-cap US equities, which are reliant on overseas revenues. That capital might flow instead to Japan and Europe, producing a rally strong enough to offset some of the local currency weakness for UK investors.
The prospect of “Trumponomics” has convinced investors that a sector rotation in US equities is starting. Tech stalwarts have been sold in favour of more cyclically exposed sectors. Healthcare and regional bank stocks have benefited from Trump’s promise of looser regulation. Industrials have been bolstered by his commitment to boost infrastructure spending. And domestically-focused small caps have looked like a good insurance policy in case his most protectionist leanings are realised.
Given the pessimism with which the market viewed Trump before the election, the strength of this rally has been remarkable. But confidence in the new President will only be truly tested once he enters the Oval Office.
There is another big threat to the “Trumpflation trade”. Improving economic data had set the Fed on the path to normalising monetary policy even before Trump’s win. And last week, chair Janet Yellen delivered by far her most optimistic statement of the year, and her rate-setting colleagues have upped their expectations for interest rate rises in 2017 to three. Such inflation-checking measures would likely strengthen the dollar, boost imports (exactly the opposite of what Trump wants), and wreak further damage on emerging markets.
Others see cause for cheer in this move towards more normal monetary policy. “Broadly, we have avoided the manifest perversity of negative rates; the social externalities of QE are likely consigned to history; zombie capitalism and the suppression of productivity can be put to rest; and the post-crisis appetite for bond-proxy equities should be sated,” said Jamie Clark, fund manager on Liontrust’s macro thematic team.
Emerging markets and commodities
“Having long been unloved, [emerging markets (EMs)] had started 2016 significantly undervalued and historically cheap,” writes Adrian Lowcock of Architas. Things got even worse with a rout in Chinese markets at the beginning of the year, as the fortunes of Indonesia, Brazil, Malaysia and other EMs which trade heavily with the Middle Kingdom are closely tied to its prosperity.
Over the course of the year, Chinese authorities continued their devaluation of the yuan, but a boom in the housing market has improved growth, acting as a balm for the time being.
Before November, EMs enjoyed hundreds of billions of dollars in capital inflows. The Fed helped things as well – exercising more reluctance to raise interest rates than investors had expected. Fears of a stronger dollar under Trump have reversed the trend to an extent. “But with EMs, the reaction is always bigger than the implications really are,” says David Lafferty of Natixis.
“It is hard to remember that back in February, we had $28 per barrel oil,” says McGrade. The price of the black stuff has risen since, and was hovering around the $50 per barrel mark before an agreement was reached between Opec and non-Opec countries to coordinate a production cut of 1.8m barrels a day from next month. By yesterday, net-long positions on West Texas Intermediate had reached their highest since July 2014.
Metals and commodities have also recovered, propelling Brazil and Russia – which have led the EM rally – even further. Miners, which had slashed capital expenditure and on low valuations, have also rebounded. Glencore and Anglo American’s share prices have risen by more than 200 and 300 per cent respectively, making them by far the biggest risers on the FTSE 100.
Fears of a global slowdown have subsided, and there is a growing acceptance that fiscal stimulus is needed to boost growth, which has made 2016 substantially better for miners of industrial metals. Gold has suffered, copper has been a surprise winner, while iron ore has more than doubled in price, having reached an all time low of $38 a year ago. Is this sustainable? Goldman Sachs has warned investors that the impact of Trump’s stimulus will not be pivotal in global terms. Indeed, the US accounts for just 4 per cent of the seaborne iron ore market, compared with 70 per cent in China.
Fears about the world’s second largest economy may have eased for now, but if China falters, elections across Europe could be the least of investors’ problems next year.