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Neil Woodford: The investment reality of Brexit and Trump

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Last year was notable for its surprises but 2017 will be the year in which those surprises start to become reality. For the UK, that may mean a year of great political change – but much less so for the economy.

It remains to be seen what flavour Brexit we will get and it will take considerably longer than 12 months before we fully understand how the economy will fare outside the EU. Some things will undoubtedly change but, on balance, the UK’s long-term prospects will not be materially different. In fact, the UK economy will continue to perform reasonably well.

I am not as bearish as some commentators but that is not to say there are no challenges, because there are. Some of these challenges are domestic but many are international. For instance, a number of important European elections loom this year, with further political surprises highly plausible. Indeed, the rise of populism, which contributed to the EU referendum outcome and swept Donald Trump to US election victory, could pose an existential threat to the eurozone project in the years ahead.

We wait to see what the first few months of a Trump presidency will look like but, here too, do not expect the outlook for the US economy to change dramatically. It would be a mistake to believe everything Trump says can ultimately be delivered. It is far from likely he will be able to do many of the things he has said he wants to.

The triggers he can pull, he will. On trade, for example, the US will probably become a bit more protectionist, although I would not want to exaggerate the speed or extent of this trend. The pendulum of globalisation has probably passed its zenith and will slowly swing back towards a more protectionist world.

More broadly, though, it is important to acknowledge that, as in the UK, the budgetary conditions within which Trump will be operating are extremely constraining. Chancellor Philip Hammond has described the UK’s public debt burden as “eye-watering” and the situation across the pond is very similar.

Prior to the election, the Congressional Budget Office was forecasting US debt would rise from 77 per cent of GDP in 2016 to 86 per cent of GDP by 2026. From a Congressional perspective, there is simply no room for the fiscal expansion Trump is proposing. At the margin, there will be tax cuts and more spending, but the room for manoeuvre is as limited there as it is in the UK.

But while it would be a mistake to believe everything Trump says will happen, the market appears to have reached a different conclusion. Much of what we have seen in the stockmarket since Trump’s election seems to exaggarate what he can deliver from a macroeconomic perspective. The Trump administration is likely to deliver slightly higher US growth than we would otherwise have seen and a strong dollar. But not to the extent the market’s reaction would suggest.

Indeed, some of Trump’s policies may have greater ramifications for emerging markets. A strong dollar has traditionally been bad news for the developing world, which is very dependent on dollar liquidity. Meanwhile, emerging economies also tend to be more trade-reliant, so Trump’s more protectionist stance could be another headwind for them. Alongside China’s deflating credit bubble and slowing economy, these are all risks to the global outlook that should be considered carefully.

Overall, we remain in a challenging global economic environment. The market was complacent about these challenges in 2016 and it is impossible to determine whether any of these concerns will translate into major problems this year. In a longer-term context, however, they are too important to ignore.

The UK stockmarket is not as cheap as it was a few years ago, so the prospect of another year of strong market returns looks remote, unless we see the resumption of robust earnings growth. This is not something I expect to see across the broader market, which suggests 2017 will be another year in which it is vital to be selective and on top of the fundamentals of both the global economy and underlying companies.

Neil Woodford is head of investments at Woodford Investment Management 

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  1. Nicholas Pleasure 17th January 2017 at 10:22 am

    One of the few fund managers who’s views I respect and who is worth his fee. Interesting piece.

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