After a turbulent and unpredictable 2016, Charles Stanley’s Chief Investment Officer Jon Cunliffe takes a look at what could be in store for global markets in the year ahead.
If there is one lesson to learn from 2016, it is to expect the unexpected. Britain’s vote to leave the European Union and the election win by Donald Trump seemed unlikely just 12 months ago – and both had a considerable impact on markets. The year started with a global growth panic over prospects in China and a continued slump in the oil price. But Wall Street managed to hit a series of new highs by the end of the year and China fears came to naught.
Charles Stanley is upbeat on the prospects for shares and we expect the FTSE 100 to reach 7,400 before the end of the year. Better global growth and a resilient UK economy, aided by the significant ease in UK financial conditions we have seen in 2016, such as a fall in the value of sterling and a post-referendum interest-rate cut, should help corporate earnings.
The sectors we expect to perform the best are cyclical, such as industrials and materials. They will benefit from better economic activity and extra infrastructure spending. In addition, financials should benefit from higher bond yields, with US banks in particular boosted by expectations of looser regulation under a Donald Trump presidency.
The sectors we are less positive on are the so called ‘bond proxies’ – the highly-rated consumer staple, pharmaceutical and utility companies which have benefited the most from the decline in bond yields in recent years. However, we would continue to favour holding a selective allocation to those companies offering superior dividend growth.
We believe that UK inflation will not rise as far as many forecasters expect and we are more bullish on UK growth than the Bank of England for 2017, expecting it to be 2% or so. One reason why we expect inflation to be relatively well behaved is to do with the intense competition in the retail sector and the challenge from the internet. So, while sterling’s weakness will inevitably cause a significant increase in import prices, much of these will not be passed on to the consumer. This will, however, have a knock on effect on retailer’s margins, which will continue to be compressed. It makes us cautious on high-street retailers.
A stronger US dollar is not necessarily negative for emerging markets.
Although the Dow Jones Industrial Average, S&P 500 and Nasdaq composite have all hit new highs recently, we expect the Russell 2000 index to outperform all the other major equity indices. It is a small cap, mainly domestically focused US equity index, and we believe that it will benefit from a combination of cyclical vigour in the US economy and expectations of a significant infrastructure programme – and, as an investment theme, we are bullish on stocks which give exposure both to US and UK infrastructure investment.
We believe the US dollar will continue to rally, particularly on a trade-weighted basis, which is weighted according to the importance of the trade with the various countries involved. In a world starved of yield the prospects of further rate hikes during 2017 and beyond should boost demand for the US dollar. Our expectation that UK fundamentals will remain favourable supports our view that sterling will keep pace with the US currency and outperform most other major currencies.
A stronger US dollar is not necessarily negative for emerging markets. For the first time in a number of years we expect to see a reacceleration in activity in these fledgling economies which will be supported by a better outlook for commodities – with the notable exception of gold – and an increasing benefit from strength in the technology sector, particularly in Asia.
We expect to see the West Texas Intermedia (WTI) oil price reach $60 or higher per barrel by the end of 2017. Saudi Arabia’s finances are under increasing pressure and we expect the cartel to attempt to make members comply with recently-agreed output cuts, in anticipation of the part-privatisation of state-owned oil group Aramco, in 2018.
The backdrop of higher inflation, better growth data and Fed rate hikes is a negative backdrop for government bonds in the developed world. We do not, however, expect a 1994-style bond bloodbath, as a further significant rise in bond yields will cause a tightening in financial conditions, given the high levels of indebtedness still evident in the household and corporate sector, so central banks will remain cautious.
We don’t like gold, unless the purpose of buying it is for a hedge against an unanticipated and adverse financial market environment. Higher interest rates, particularly in the US, will increase the cost of holding precious metals and a stronger dollar will tend to depress their price.
The above article was first published by Charles Stanley on 22nd December 2016.