Economic and Markets Outlook 2017

Introduction:

image of a golden globe with the year 2017 hovering above suggesting the economic and markets outlook 2017Formulating an economic and markets outlook 2017 gives us a platform from which to guide our investment philosophy for the year ahead. We share it with our clients as part of the transparency of our process in fulfilling our fiduciary responsibilities to them – and for the interest of our readers generally.

In a fundamental approach to investment asset values, economies and their constituent performances guide investors as to their risk and return expectations when dealing with investable assets: in financial terms, this particularly relates to equities (shares), to property; and to cash (and cash substitutes – fixed income products). [For a detailed analysis of the investment risk characteristics of these asset classes, read our article ‘Investment Portfolio Diversification‘.]

In presenting our for economic and markets outlook 2017, we note a generalisation by one forecaster that fairly much encapsulates our own view of the financial scenarios we face for the year, stating that ‘…2017 should be a modestly positive year, continuing the long recovery from the GFC – but with four key differences over recent years as we move through 2017:-

  • Populism is challenging globalism and creating new tail risks.
  • Concerns about low growth are giving way to concerns about inflation.
  • Years of focus on monetary policy are giving way to a close watch over fiscal policy; and
  • Concerns about new regulation are acceding to hopes for de-regulation.

Investors – including fund managers – look to economic conditions in different regions to determine the financial impact on the assets in which they invest. Our comments begin with the economic positioning in key regions (domestic; and major trading partners); and then extrapolates those influences to how we see the markets behaving in relative regions. Readers should note that investment markets available to Australian investors are broader than being limited to Australia’s most influential trade partners.

Economic outlook 2017–

In generalised, global terms, we expect 2017 to be a year of some consolidation economically: the global GDP is anticipated to be around 3.4%. Most central banks are reducing the ‘easing bias’ they have had, particularly in the developing economies; and in the case of the USA, the Fed is normalising the interest rate for that economy.

Whilst US President Trump has cast an ominous cloud over ‘free’ trade, the rest of the world will seek to open their trading borders and increase the productivity of their workforces – and it appears that a modest level of inflation, a ‘good’ level, should return during 2017.

Individuals should start to experience higher levels of confidence – and those with limited, or no debt should start to spend, with positive effects on the economy.

In selected cases, we see the economic outlook as follows…

Australia:

  • Exports are our main source of income: value of the AUD against our trading partners will impact; dollar needs to retreat further yet. Early-2017 trade surplus may be a short-lived gain. Developments for our major trading partners will be important: we include China, Japan, the USA and India as those of particular interest in this regard.
  • Transition from mining and manufacturing, to services economy to progress, but continues at a slow pace. We expect GDP for the twelve months to be around 3% on our reading of the various industry reports.
  • Housing construction likely to contract, putting pressure on unemployment stats, consumer sentiment – and negatively impacting on retail sector. The time-lag for local authorities to clear the way for increased land supply; and the desirability of living within 20-minutes from work mean that it may be another year or two before there is a recovery in this area (which has enjoyed almost three years of growth until late-2016).
  • RBA has official rates so low, they now have limited capacity to influence either markets, or the currency: some forecasters are suggesting they will cut twice this year, to end at 1.00% (but this isn’t widely supported – and our own view is that whilst there may be two moves by the RBA on interest rates during the year, the end result will be where we start the year – at 1.50%. Commercial interest rates are increasing without intervention by the RBA and so there is less pressure on them to act.
  • Fiscal developments would be most effective to stimulate the economy and to keep the transition ‘on track’, but current political scenario is not conducive to any significant developments.
  • Political instability is likely to be the norm for 2017, both here in Australia and elsewhere in democratic countries across the globe who have elections due (primarily in Europe this year): it is not impossible that Australia could have a Federal election later in the year if the early signs play out.

Our Trading Partners:

China:

  • Political undercurrents develop as the leadership group transitions to a younger team: changes are due over the next year or so.
  • Economic developments should continue to focus on transitioning the economy from an export-driven, to a consumption economy. Recent improvement in the global steel industry bode well for our continued sale of iron ore and coking coal to this trade partner.
  • China’s relationships in the region – and with the USA – could impact their economic development this year; and it could also impact their willingness to trade with Australia. The relationships of most interest are those with North Korea, Japan, the Philippines and their continental neighbours.
  • Whilst it is difficult to have comfort with the published stats, growth will probably be reported at around 7% for the year.

Japan:

  • ‘Abenomics’ continues as an experiment – and with questioned success: the ageing population, intolerance for immigration, low birth rates and a low-growth economy do not give confidence that growth will be anything but sub-par for 2017.
  • The failure to secure ‘the submarine deal’ may cool the trading relationship between Japan and Australia, but for 2017, we don’t anticipate any significant downturn on that front.
  • Low, even negative interest rates are impeding the development of a ‘healthy’ level of inflation for Japan. Measured against the USD, the yen is expected to fall further during the year.

The USA:

  • The election of Donald Trump as President has surprised many – and has brought a decidedly unwelcome level of uncertainty to global trade and relationships: his naïve approach to global diplomacy has set many of the trading partners and defence alliances, on edge.
  • As bold as the claims made by the new President that he would ‘make America great again’, the attempts at their implementation is going to be interesting to watch – and gives rise to the questions: what will it mean if America is to be great again? …and in whose eyes is it to be seen as great again?
  • In the first few weeks of the Presidency, some attempts to implement the ‘policies’ on which he campaigned have proven either ineffectual, or are being challenged in Courts in the US.
  • The President’s attempts to revitalise the economy in the US and to get people back into decent jobs, are being made at a time when unemployment is low, interest rates are low, inflation and growth are low – and trust in the US as a trading and defence partner, is declining (as a consequence of his actions).
  • We expect the USA to report GDP growth for 2017 at between 2% and 3%; for their sharemarket to grow by between 5% and 7% (there is a proclivity toward the lower end of this range amongst forecasters’ commentaries we have read); for inflation to increase (perhaps beyond the Fed’s target range) in response to wage pressures; and for there to be two interest-rate rises by the Fed (with both of those rises most likely to happen in the second half of the year). [Other inflationary pressures on the US economy, include the projected infrastructure spend – although that will take time to initiate; and the imposition of trade tariffs, if they are introduced to impose the trade restrictions proposed by the President during his pre-election campaign.]
  • Whilst there is a positive outlook for the 2017 year, there is concern arising that some of the US President’s policies may lead to a recession by early 2018: watch this space, as they say.

India:

  • Whilst India has not traditionally been a strong trading partner for Australia, as its economy transitions to include a higher proportion of middle class families, the demand for both mineral and agricultural commodities/ products from Australia will continue to increase.
  • Recent actions to curb corruption in India (by removing high value paper currency from circulation) have had an impact on the banking sector – and on internal trade generally: this may slow down the rate of improvement in living standard for this country.
  • Infrastructure enhancement, indeed, development, will be a key to growth and productivity in India: Australia will benefit from the demand for mineral resources that will accompany the growth of the electricity distribution network and the improvement of generation capacity.

Globally:

  • Many countries are attempting to keep a competitive trade advantage by taking any reasonable means to lower the exchange rate on their currency: these attempts are ultimately futile, although they have short-term advantage when timed correctly. We expect to see more ‘talking down’ of currencies; as well as market intervention when required.
  • The major economic blocks are out of step with each other in their recoveries from the after-effects of the GFC. The USA and China are ahead of the rest in this regard; Europe and Japan are thought to be about three years behind the USA (and with instability in the EU – and its adoption of the Euro, there could be further delays for them); other emerging economies are struggling and remain very dependent on the USA and other more developed economies for both economic direction and financial support. Overall, the outlook for global growth projected by the IMF for 2017, is 3.4%.

Markets outlook 2017–

In keeping with the modestly positive economic outlook for 2017, we also expect there to be positive results over the year in most markets. Remembering that markets generally indicate future economic conditions1; and that share markets in particular, react quickly to any unexpected news or profound uncertainty, we anticipate that there will volatility in the share and bond markets that will provide opportunities for traders and tactical opportunities for investors during 2017.

[1 For more on this relationship between economics and the markets, refer to our article ‘Investment Markets and Investor Behaviour‘.]

Subject to a view on hedging international investments, we believe that, in local currency terms, the majority of investable markets will generate a positive outcome for the year. Dealing specifically with the equities, property and cash (fixed income) markets within some particular economies, we detail our outlook for 2017 below…

Australia:

  • Equities (shares) in Australia have continued to increase in value at what some might consider ‘a snail’s pace’, but given the high level of dividends (and the accompanying imputation credit) the returns for Australian investors have been at the high-single digits level for a couple of years. Share market prices have been more constrained in Australia than in markets with less favourable tax treatment. There is too much political, including geopolitical uncertainty to be able to make a confident prediction as to the direction of the Australian sharemarket for 2017: but at a forced guess, we would be satisfied with a flat year on prices, with continued dividend returns providing most of the reward for share investors.
  • Property, from an investor viewpoint, is generally commercial – factories, offices and shops; until the economy grows more convincingly, the demand for these properties remains subdued. Even residential property, which is also an employment intense industry, is expected to be subdued for 2017. Unless there are fiscal measures taken to improve the outlook, we don’t expect much growth for this sector: flat, to perhaps modestly negative.
  • Cash and cash ‘equivalents’ (such as fixed income, bonds) has provided very low returns in recent years – and without demand driven incentive to have more competition for the funds available (that would come from increased construction activity, strong manufacturing for export, or infrastructure development), we don’t anticipate there being any significant change in official interest rates, or investment yields on this asset, for 2017.

The USA:

  • Equities in the USA are poised, even at their elevated valuations, for a further increase in value during the year. This is supported by the improving growth of the economy, the perception of a more business-favouring President, the very gradual ‘normalising’ of the official interest rate by the Federal Reserve Bank (the Fed); and where that country is, in its economic cycle. (The US stock market represents around 40% of the world’s value of equities and so is heavily represented in diversified investment portfolios, global equities allocation.) We anticipate growth in the high single digits for 2017.
  • Property, even in the USA is undergoing some challenges, recognising the cumulative effects of increasing technology in use in workplace environments, a preference by workers to have a work-life trade-off in their decision about where they will work – and, until the Trump attack on free trade has its effect, a broader distribution of manufacturing facilities and supply-chain logistics. Whilst low interest rates would traditionally be considered a positive for this part of the market, this is of less importance today. We expect flat to low single digit growth in this asset for 2107.
  • Cash and fixed interest markets are somewhat of an outlier in the current environment: interest rates are low, regulations are tightening in relation to lending, GDP is subdued around the world; and, as these conditions have prevailed for quite some time, with commercial pressures on interest rates rising, the significant volume of Bonds (both government and corporate) issued when rates were lower, will be under pressure to devalue to provide yield matching those rising interest rates.

The rest of the world:

  • Equities in all other markets will move according to local conditions, but affected by what happens on the major exchanges (in New York, London etc) – and be influenced by what happens in emerging economies. We expect there to be little growth overall – but obviously expect there will be pockets of sound growth providing excellent investment opportunities (others will be not so favourable, including some that will be negative over the year). [One forecast has the global equities market increasing by between 5% and 8% for 2017.]
  • Property is similarly expected to stay flat globally. There is no obvious impetus for growth in this asset, other than in a spasmodic, local and/ or specialised sense.
  • Cash and fixed interest will be favourable in the ‘rest of the world’ market place in the wake of the larger, developed economies absorbing the safe investors’ funds, leaving the others to fight it out for the limited funds available. Provided investors can bear the risk, some good returns should be available – with appropriate hedging.

The ContinuumFP application of the Economic and Markets Outlook 2017

In the context of this outlook, Continuum Financial Planners Pty Ltd looks to various fund managers, researchers and analysts to satisfy ourselves that the products we have recommended to clients, continue to be managed in concert with the strategies adopted by the client – and consistent with investment strategies and philosophies that were indicated to us at the time of placing funds with them.

For 2017, we favour managers who are well supported with broad-based research, have a proven track record of ‘true to label’ consistency, are appropriately positioned to be able to take advantage of buying opportunities – and who sell, when the analysis indicates that is the correct trade, regardless of any ‘gut-feel’ or constructive bias they may hold.

Our supported managers in the equities space will be investing in businesses that have sound balance sheets (low levels of debt), sustainable business models, are price makers – and who operate under sound governance. Supported Property managers will be invested in property with reasonable levels of debt, strong tenancies – and funding distributions from net income generated.  Supported Bond managers will have short- to medium-term duration in their portfolios – and be nimble in making trades, aware that these markets can turn quickly.

If you would like to engage with us on this topic – or in response to it – please call our office; or use the Contact Us facility through our website: you will receive prompt and courteous attention.