State Street Global Advisors (SSGA), the asset management business of State Street Corporation (NYSE: STT), today released its global market outlook and key investment themes for 2017. In the report, SSGA points to 2017 being another year with top-down global, political and policy developments that will have an outsized impact on investment returns.
“Seismic geopolitical events, most notably the Trump presidency and Brexit surprises, marked 2016 as a game-changer across the geopolitical landscape, with significant implications for economies and markets alike,” said Rick Lacaille, global chief investment officer for SSGA. “Populist politics and anti-globalization sentiment have set the stage for significant policy change in 2017 and beyond. In our view, some of the leading themes that have served investors well over the past several years are shifting in the face of a changing investment backdrop. Investors will need to consider areas of the market that will benefit or suffer from a possible reflationary environment, altering, for example, the search for yield.”
A Focus on Fiscal Policy
“With many central banks now short of policy ammunition, reluctance to employ fiscal stimulus has finally waned,” said Chris Probyn, chief economist at SSGA. “Austerity is less pronounced in continental Europe. The UK is delaying its planned return to budget surplus following the EU referendum result. Canada and Japan are introducing stimulus packages. China is using targeted fiscal measures to help cushion growth and transition to a more consumer-driven economy. And President-elect Trump’s proposals for tax cuts and additional infrastructure spending could potentially boost US growth to near 3.0% over the near term.”
“Similarly, the International Monetary Fund has endorsed increased government spending, recently stating that fiscal support ‘remains essential for generating momentum and avoiding a lasting downshift in medium-term inflation expectations,’” continued Probyn. “Investors, however, must decide how much faith they should put in the government’s purse and what areas of the market it’s likely to impact.”
Elections to Watch
“The potential for further political tumult to impact markets in 2017 abounds,” said Lori Heinel, deputy global chief investment officer at SSGA.
“Major elections in Europe will intensify concerns of further destabilization of the euro — most notably in France where the Eurosceptic National Front Party has grown in popularity. There remains a very strong incentive for EU officials to do whatever it takes to maintain the monetary union. It only takes the idea of instability to incite fear among investors and this sensitivity could drive euro weakness during the first half of 2017,” continued Heinel. “While there is still a great deal of uncertainty around final effects, we can already see that some of these changes will likely hasten shifts that are already underway.”
“With monetary policy perhaps at its limits to stimulate growth, a turn towards fiscal stimulus (which will also serve to appease social discontent in some countries) is likely in 2017,” added Heinel. “But political tensions could limit the scope and effectiveness, and the knock on effects could lead to more volatility and more differentiation between market winners and losers.”
Protectionism on the Rise
Proposed global trading agreements are losing support across all markets and the incoming US presidential administration opposes the 12-nation Trans Pacific Partnership. Moreover, the number of protectionist trade measures imposed globally in 2016 is five times as many as through the same period last year. “A broad reversal in global trade is almost certainly a negative for global growth and is consistent with our modest return forecasts for global equities,” said Dan Farley, chief investment officer for SSGA’s Investment Solutions Group. “Within certain local industries, however, protection will be beneficial as firms become more competitive domestically, just as it will be a drag on companies with substantial global exposure.”
Policy Shift: A Game Changer for Investors?
After years of unconventional monetary policy to combat stubbornly low growth and inflation, the US is cautiously proceeding with rate normalization, while central banks in Europe and Japan have shown some hesitation to extend negative interest rates and asset purchase programs.
“With monetary policy perhaps at its limits to stimulate growth, a turn towards fiscal stimulus (which will also serve to appease social discontent in some countries) is likely in 2017,” said Heinel. “This begs the question: what additional tools, if any, are available to global central bankers if what has already been tried no longer works?”
Translating rhetoric into action around fiscal expansion and infrastructure spending could spawn a virtuous cycle of increased spending, rising confidence, and perhaps re-ignition of the US as the global economic engine. At the same time, faster inflation and rising interest rates will put pressure on bonds.
Summary of SSGA’s Near-Term Portfolio Strategy
In the quest for equity growth, SSGA believes investors should be particularly thoughtful about which sectors they choose, as certain areas of the market have been bid up to uncomfortably high valuations. Some investors may need to diversify to allocations that could benefit from a rising rate environment. For those seeking yield, the evolving profile of bond and equity markets will demand a more nuanced and cautious approach.
Meanwhile, patterns of volatility suggest heightened risks for equity markets in 2017, and the Federal Reserve’s capacity to temper extremes appears increasingly stretched. As such, investors should revisit their volatility management and currency hedging strategies. Tail risk hedging, dynamic or tactical overlays that deliver alpha or reduce risk, or other diversifiers can help to prepare for the uncertain environment ahead.
- After five consecutive quarters of negative earnings growth for the S&P 500, it turned positive in the third quarter of 2016 and we expect it to remain positive in Q4
- We anticipate that Fed interest rate increases should be a boon for financials, boosting interest margins, but may limit sectors such as consumer discretionary that have benefited from an easier borrowing environment
- The one-year forecast for equities in developed markets (ex-US) is comparable to our 3.3% US forecast, therefore we urge investors to tread with caution toward international equities with underweight positions in developed European and Asia-Pacific regions
- Our forecast for emerging market equities is six percent for 2017 on a stronger growth outlook as Russia and Brazil emerge from recession and as the negative impact of falling commodity prices has abated
- We believe fear-record low yields provide a poor starting point from which to invest in global fixed income markets and without price appreciation from even lower yields, this group of securities can only provide negative returns
- For US 10-year bonds, we forecast a one-year return of 0.3%, and a negative 0.3% return for developed market government bonds outside the US
Credit and High Yield
- In our view, the US credit and high yield debt seems favorable with one-year forecasts of two percent and 5.1%, respectively
- Our research indicates that while oil has made an impressive comeback since the early-2016 lows, a continued supply glut and modest global growth will probably keep energy range-bound with a slight upward bias in 2017
- We predict that precious metals, such as gold, should continue to do well in an environment with widespread negative global interest rates and a gradual return to higher levels of inflation
“Ultimately, we see 2017 as a year that will continue to be punctuated by significant, and at times unpredictable, political and economic change.” said Lacaille. “Overall investors will need to consider how best to position their portfolios for the opportunities and risks these changes bring.”