The exquisite unpredictability of markets was on full parade in 2016, and investors are still breathless. Very few believed populist anger would lead to a Brexit or a President Trump, or that a crashing oil market would be rescued by a deal underpinned by Saudi altruism towards Iran.
Indeed, markets are replete with occurrences which make mockeries of expectation. Here are some unlikely – but eminently feasible – scenarios that the markets are not pricing in for 2017.
1. Anno Trumpini: Post-Trump expectations of US growth fall flat, but Europe is a champion.
In the aftermath of the US election, global investors appear convinced that huge US infrastructure spending and slashed taxes will bring about President Trump’s “guaranteed” annual economic growth rate of 3.5 per cent, and stoke inflation.
But there are strong reasons why this may not happen. That level of growth has not been hit in the US for over a decade, and wildly pumping fiscal stimulus into the economy will do nothing to address fundamentally poor demographics – made worse by immigration curbs – or slowing productivity. It will certainly not help underemployed people get the high-paying jobs for which they don’t have the skills.
There could also be some major negative shock, perhaps of the President’s own making – a scandal causing him to rapidly lose his mandate to govern? The Federal Reserve may well spend another year being much less active than it sets out to be.
Conversely, expectations are for the Eurozone to meander along, growing well under 2 per cent, a little better than recent years, but still deep in a rut. However, conditions on the ground would suggest a breakout year for the Eurozone is possible.
Unemployment has finally crossed below 10 per cent, an important milestone in the Continental recovery. Economic confidence is at multi-year highs. Inflation has leapt to 1.1 per cent; just months ago deflation seemed imminent.
However, this recovery may finally give the Germans enough reason to force the European Central Bank to tighten monetary policy by reducing quantitative easing and raising rates. The Eurozone powerhouse is doing well economically, and wants all this stimulus to end before it causes it to overheat.
2. Not so hard: Brexit negotiations go fabulously well.
The prevailing consensus is that Brexit will take longer, and be tougher, than expected. The vast majority of economists still believe Brexit will harm the UK’s longer-term economic prospects. The British pound is taking the brunt of the political uncertainty, beginning 2017 at multi-decade lows.
Of course, the majority of pundits could well be wrong... again. Europe has huge incentives to treat the UK well in negotiations, and many thorny issues may well be resolved this year. The UK is Europe’s “investment banker”: the City provides 75 per cent of foreign exchange trading and hedging products for the EU, and supports half of all lending. Moreover, the UK exports £26bn of financial services to the EU, and imports just £3bn. A sharp break in that liquidity and capacity support could be detrimental to financial stability in the EU. On the other hand, the UK could easily find alternative suppliers of chemicals and wine. This gives the UK more leverage than many believe.
3. Bone China: The long-awaited implosion happens this year.
China remains stable, unbelievably so. Fears of an economic implosion rocked markets early last year, but the country remarkably grew at an annualised rate of 6.7 per cent in the first three quarters, bang in the centre of its stated target of between 6.5 per cent and 7 per cent. Guess what? The Chinese vice finance minister states he is confident his country grew at an annual rate of 6.7 per cent in the fourth quarter of 2016 too.
Even if these figures are real, authorities were forced to rely once again on leverage-driven infrastructure spending to prevent a short-term crisis. Banks were also encouraged to lend to the private sector, but much of this ended up in housing: prices in first-tier cities such as Shanghai were up by 30 per cent in 2016.
The Chinese yuan is at an eight year low versus the US dollar, down over 6 per cent in 2016, and the country’s foreign currency reserves continue to fall: just two years ago reserves were $4 trillion; they are $3.1 trillion now. These are signs that all is not well on the inside. Many experts expect a day of reckoning to come at some point. It may well be this year.
Pollsters, political prognosticators, financial forecasters and average punters will be wrong about many of their expectations for 2017. Even if they are right, there is no way to know how markets will react in the short term.
The only way to act as a prudent steward of capital is by keeping an iron focus on indelible drivers of long-term asset returns such as valuation, momentum and sentiment. Everything else is just noise.