This year is being heralded as a new dawn for markets. The economic malaise which has dogged developed economies since the financial crisis will finally subside; the battle against deflation has been won; fiscal stimulus is firmly on the agenda, and real growth will return.
Such optimistic assessments may prove to be on the money. The consensus view is that Donald Trump's low-tax, high-spend agenda will boost growth in the US next year to 2.2 per cent. Many analysts see that figure as too conservative, and think that Trumponomics could deliver 3 per cent and maybe more. But much of the post-election rally in equities has been based on the assumption that the property tycoon is all talk; that Congress can file down his sharper edges; and that he will avoid a trade war with China which could see tariffs soar and volumes plummet.
If there was too much complacency going into 2016 – with strong odds that Remain, Hillary Clinton or even Ted Cruz would emerge victorious – investors should be more cautious this year. Trump has yet to enter the White House; Article 50 has yet to be triggered. The real risk events have not yet occurred. So what should we expect?
The great divergence
More growth in the US is virtually guaranteed under Trump, who will be buttressed by Republican control of both houses of Congress. Higher interest rates will be needed to keep a lid on the inflation his policies will generate, especially if the oil price continues to rise. The $1 trillion fiscal stimulus he has proposed would stoke inflation and raise yields, and could bring the 35-year bull market in bonds to a close.
This is likely to be good for equities. Almost two thirds of JP Morgan Private Bank’s clients believe public stocks will be the best performing asset class over the next 12 months, with 32 per cent saying that the US will outperform other markets – one Merrill Lynch strategist has said that US stocks could gain up to 20 per cent in 2017.
For the next year at least, the Fed’s policy is likely to diverge with regions such as Japan and the Eurozone, where deflation is still a risk. This could help Japanese and European equities – rising interest US rates will lure dollars back to the States, strengthening the greenback and making exporting firms from the Eurozone and Japan more competitive and their shares look cheaper. This is already being seen. After a December rally, Japan's Nikkei 225 ended 2016 at 19,114, locking in its fifth consecutive year-on-year rise.
But bank balance sheet repair in both these regions has been painfully slow, and there are no guarantees that growth will pick up. If the outcome of elections in Europe in 2017 produces volatility, the ECB may keep monetary policy accommodative. The Bank of England will not be eager to raise rates this year either until the outlines of a Brexit deal emerge.
So which stocks should you buy? Financials, healthcare industrials and other cyclical sectors have had all the running since Brexit and Trump's election, in the expectation that we are at the beginning of a rotation, and this is likely to continue. "Consumer stocks and the so-called Fangs (Facebook, Amazon, Netflix and Google) will not fall off a cliff, but value shares will overtake growth ones," says Michelle McGrade. Snapchat's owner Snap Inc is expected to float at some point, but price to sales ratio would be very low in comparison to Facebook and Twitter when they listed, and the climate is not favourable for tech IPOs. "If the oil price keeps rising, oil majors' dividends will be safe. Lloyds has started paying a dividend and that's not going to stop," she adds.
As monetary policy starts to tighten and liquidity dries up, 2017 may be more about picking stocks than choosing sectors. "In this world, a focus on valuations and fundamentals – old school investing if you like – should be more important than it has been in recent years, when markets were backstopped by abundant and growing liquidity," writes Mark Burgess, EMEA chief investment officer and global head of equities at Columbia Threadneedle.
But there is much which could derail this growth. Even if you set aside his potentially incendiary trade policy, Trump's tax plans are ambitious, and the fiscal stimulus America actually gets may well undershoot the $1 trillion he has talked about.
The President-elect has between now and March – when the new debt ceiling is voted on – to convince Tea Party detractors who are more fiscally conservative that loading up on debt is a good idea, and that he has the right infrastructure projects spend the money on.
Iain Tait, partner at London & Capital thinks investors have been too exuberant about Trump's chances, with growth expectations exceeding the fundamental operating performances of stocks. Tait envisages a repeat of 2013, "with the reality being re-asserted that we are in a multi-decade new norm of low growth and low inflation, with short-term measures to boost inflation proving short-lived." He recommends real-estate investment trusts, which have attractive valuations and will outperform bond yields as the outlook for real estate becomes more favourable.
In any case, not every rich world economy which has recognised the limits of monetary policy is sold on the idea of fiscal stimulus as a treatment for economic stagnation. Inside the Eurozone, Greece has been made to adopt austerity measures in exchange for bailout funds. It is unlikely that Germany – which has a budget surplus and could benefit from more spending, but views public debt as a source of national shame – would allow the euro area to ditch its prudence over the next year.
The new normal?
After years of low growth and eye-watering levels of youth unemployment in many EU countries, Eurosceptic parties are now criticising some of the bloc's most central and inflexible tenets – the free movement of people, its ban on state aid, and the inability of euro area countries to devalue their currencies. With key elections coming up in the Netherlands, Germany and France this year, a strong nationalist message could deliver some political upsets, and the protectionism of France's National Front, for example, could hamper growth even further. Political uncertainty will define 2017 as it did 2016, with commentators speculating endlessly about which electoral hammer blow will cause the EU's whole edifice to crumble.
It is unlikely to come in March, when the Dutch vote in parliamentary elections. A poll of polls in late December showed that Geert Wilders had consolidated support for his far-right Freedom Party since being convicted for incitement to discrimination, and could win 31-37 of the parliament's 150 seats. Wilders is proposing to close borders and hold a vote on the Netherlands' EU membership. However, support for Nexit is not very strong. A survey by the European Commission found that only 19 per cent of Dutch people thought their country would fare better outside the bloc.
However, Stephen Brown of Capital Economics thinks that the Dutch could create fissures in other ways, by voting against significant debt relief for Greece, for example. "And sweeping changes to the EU will require Dutch politicians to pass new laws or treaty changes, which would almost certainly trigger referendums under the Advisory Referendum Act," he said.
In France, opinion polls suggest that Republican presidential candidate Francois Fillon is expected to beat the Front National's Marine Le Pen in May's second round run-off. But his Thatcherite agenda and pledge to end the statutory 35-hour working week may be hard for the French people to digest. Le Pen's economic policy, though protectionist, would afford French citizens many of the benefits they're used to. It would be foolish to write off her chances.
Germany's right-wing insurgents, Alternative for Germany, are unlikely to be invited into any coalition government after the federal election in the autumn. But its fierce criticism of Chancellor Angela Merkel's open-door refugee policy has weakened her popularity among voters, her Social Democratic Party (SPD) coalition partners and even within her own Christian Democratic Union (CDU). Former chancellor Gerhard Schroder has said that Merkel's CDU could be ousted altogether, if the SPD gets the numbers to partner with the Left Party and the Greens in a "red-red-green" coalition. This is highly unlikely, but Merkel is blamed for the EU's intransigence, and its complexion could look very different in her absence.
However, second-guessing the results of elections, or what populists may try to achieve in power may be foolish in itself. "Uncertainty does not imply widespread volatility," writes BlackRock's global chief investment strategist Richard Turnill. "Instead, political surprises and initial sell-offs were seized on [last year] as buying opportunities." So even if Le Pen wins and Merkel is ousted, many will hesitate before selling off in the manner they did immediately after the Brexit vote, only for UK equities to soar after the shock died down.