While Trump blazes blond in the political foreground, it’s easy to overlook the economic background to the new political dimension of 2017. Political risk will be a feature of the year: the unpredictable and untested Trump administration has already created uncertainty, which is unlikely to diminish, especially if protectionist rhetoric starts to outweigh promises of stimulus. Nevertheless, in the macroeconomic backdrop, global growth is picking up and monetary policy is likely to remain loose in most developed countries, despite a pick-up in inflation.
Bouts of volatility and market shocks are likely to occur during the year as a direct result of political risk, not only in the US but also in Continental Europe, with its string of leadership elections, and the UK, where Brexit negotiations wait in the wings.
Looking through an asset allocation lens, our ‘investment clock’ model is in its ‘overheat’ phase, as the global economy marches through what looks to be the strongest surge in nominal growth since the financial crisis. Our indicators show that a recovery in growth was already under way before the US election, and Trump’s election victory, with his promises of corporate tax cuts and fiscal stimulus, is likely to keep the model in its current position.
This environment is positive for equities and commodities, and the potential for deregulation and stimulus actions in the US could add further fuel to the fire. Few central banks are likely to respond to higher inflation by raising rates; the European Central Bank and the Bank of Japan are printing money, and the Bank of England will want to keep policy loose while Brexit negotiations unfold. This continuation of loose monetary policy in a number of core economies should provide further support for equity markets. With only the US Federal Reserve gradually tightening monetary policy, interest rate differentials will continue to rise, supporting the US dollar.
Meanwhile, data from China also demonstrate a strong upturn, providing further support for global growth, inflation and commodity prices. The US dollar often, however, proves to be a headwind for commodities; while we have overweight positions in both commodities and equities, we therefore prefer the latter.
Strong global growth is typically good for both Japanese and emerging market equities, but we remain wary of the potential for punitive ‘border taxes’ on the latter. Interestingly, Japan tends to outperform emerging market pretty consistently in a strong US dollar environment, such as the one we are seeing at the moment. Flashes of dollar weakness, perhaps linked to political events, could therefore provide buying opportunities.
Using our core asset class views to interpret the macroeconomic background enables us to take advantage of opportunities that arise from market volatility, of which we expect to see much this year on account of the global political environment.
For professional customers only. The views expressed are the author’s own and do not constitute investment advice.
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Financial promotion issued by Royal London Asset Management February 2017. Information correct at that date unless otherwise stated.
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