After a year of seismic political shifts, 2017 has so far continued to provide extraordinary headlines on a daily basis. Yet life goes on. Let’s not forget that, a year ago, markets were in freefall and you did not have to look far to find predictions of doom and cries of “sell everything”.
In defiance of those expectations, as well as events such as the Brexit vote, stockmarkets in both the UK and the US ended 2016 at all-time highs, and they have continued to rise into the early part of this year. I hope you stayed invested when others were losing their heads.
One key challenge for investors at the moment is filtering out the short-term bluster from anything that could be genuinely transformative for economies and markets over the medium to long term.
At least one question has been cleared up: Donald Trump really did mean all those things he said on the campaign trail and is trying his damnedest to implement them, regardless of the outcry it causes in some quarters.
So far we have seen executive orders repealing the Trans Pacific Trade Partnership, a reversal of President Obama’s policies on two US oil pipelines and the Affordable Care Act, an ordering of the famous wall to be built on the Mexican border and a ban on immigrants seeking access to the US from seven Muslim-majority countries.
If that was not enough, Trump has continued antagonising the Chinese with threats of a trade war and his administration’s attitude to Russia is, at best, incoherent. On the other hand, he has made supportive noises towards the UK, praising Brexit, and reaffirmed the US’s support for Nato.
Growth and inflation
So what are the implications for investors? Markets were already in a state of flux, to which Trump and the upcoming elections in France, the Netherlands, Germany and perhaps Italy all add an extra dimension of uncertainty.
It is important to recognise that global economic growth is in pretty good shape, with estimates of 3.4 per cent this year compared with 3 per cent in 2016.
Growth is better than the alternative but it does bring increased inflationary pressure.
It has only been about a year since inflation was hovering around zero in developed economies but it has risen to 1.7 per cent in the eurozone and 1.6 per cent in the UK. Such figures might seem a mere trifle to those of you who remember the 1970s but the direction and pace of change is important, and there is no reason to believe it will reverse course.
The marginal benefits of central bank monetary policy (that is, interest rates and quantitative easing) appear to be wearing thin, and the result is that governments are minded to spend more of their taxpayers’ money in an effort to stimulate growth.
Importantly, of course, rising inflation has implications for central bank interest rates.
The prospect of rising interest rates is reflected in bond markets. The starting point for investors is the risk-free rate, which represents the baseline rate of return an investor expects to receive without taking any risk.
The accepted global proxy for such a “risk-free” investment is the US 10-year treasury bond (although even this is not absolutely risk-free). On the eve of Trump’s election victory, 10-year treasuries were 1.86 per cent and they now stand at around 2.4 per cent. Investors are therefore expecting a higher rate of return even when, at least notionally, they are not taking any risk.
Investors with an appetite for risk greater than zero naturally expect an even higher rate of return but how much of this “risk premium” they demand will depend on all the factors mentioned above (and more) in the economic and political kaleidoscope.
It is certainly all rather complex and I would view with suspicion anyone who claims to know how it will play out. Investors should consider a wide range of outcomes, with a mind to mitigating downside risk as much as trying to chase the upside, and be asking themselves a lot of questions starting with “What if…?”
John Chatfeild-Roberts is head of strategy for the Jupiter Independent Funds Team