The global uncertainty principle and why investors should care…

The basic assumption by markets at the moment is that President Trump and the Republican administration will engage in fiscal stimulus. The question to ask is whether that fiscal stimulus is successful or whether it will end in failure. If it is successful then perhaps it will lead to US dollar strength and growth both in the US and the rest of the world and perhaps even a normalisation of the US Treasury curve. If it doesn’t succeed, as many people expect, then likely there will be a reversal of market expectations, an increase in policy uncertainty and perhaps a lower growth profile than currently priced in. These two routes have very different outcomes for the prospects of emerging market fixed income and equity markets.

There are some variables around this. First, think about President Trump and his tweets: they generate a significant amount of headline risk as we have seen already in the early weeks of his administration. That in turn creates uncertainty and perhaps a higher risk premium for some of the emerging markets such as China and Mexico and even for developed markets like Europe. It is too early to tell the result of this rhetoric but there is definitely a whiff of protectionism in the air.

The other variable is whether the Republicans in control of Congress have a high enough tolerance to increase the deficit in order to engage in this type of fiscal stimulus, which is not particularly clear to us at this point. Putting all this together, we believe the level of uncertainty in markets is going to fluctuate a lot over the next few months.

Colm McDonagh – Insight, a BNY Mellon company

The basic assumption by markets at the moment is that President Trump and the Republican administration will engage in fiscal stimulus. The question to ask is whether that fiscal stimulus is successful or whether it will end in failure. If it is successful then perhaps it will lead to US dollar strength and growth both in the US and the … read more

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Beware the bond market mirror

Last year, we saw government bonds rally and then fall, while high-yield bonds struggled and then rallied. It looks like this year we could see a similar pattern but in reverse.

The stronger economic growth momentum and rising inflation statistics are the driving force for higher government bond yields. In addition, a number of President Trump’s pledges such as pro-business policies and infrastructure spending could be positive for the economy, leading to higher growth and inflation – a bearish environment for bonds.

However, his more controversial campaign promises, including protectionist trade policies and an immigration clampdown, could lead to a flight to safety – a boost for bonds perceived as ‘safe-havens’. We are concerned that risk markets are currently complacent about this uncertainty, with investors seemingly buying into the good news rather than taking account of any potential problems.

Paul Brain – Newton, a BNY Mellon company

Last year, we saw government bonds rally and then fall, while high-yield bonds struggled and then rallied. It looks like this year we could see a similar pattern but in reverse. The stronger economic growth momentum and rising inflation statistics are the driving force for higher government bond yields. In addition, a number of President Trump’s pledges such as pro-business … read more

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Heavy weather for BoE inflation forecasts?

Market pricing would suggest investors are anticipating a prolonged period in which inflation overshoots the Bank of England’s (BoE) inflation target. The BoE asserts any pickup in inflation is likely to be temporary. As market expectations and official inflation forecasts fall further out of sync, the reality that emerges will have significant implications for holders of nominal and inflation-linked bonds alike.

The BoE’s rate-setting committee, the Monetary Policy Committee (MPC), has been reluctant to increase official rates in the face of higher inflation, owing to what it considers to be temporary factors. And, for now, it can point to public expectations for UK inflation being relatively well contained. This is reminiscent of 2011, when the BoE “looked through” price rises at a time when commodity prices were soaring and value-added tax was being increased. Inflation, as measured by the consumer price index, peaked above 5% that year.

Holders of nominal bonds need to be certain that the current increase in inflation is being driven by temporary factors, as the MPC asserts. If the BoE’s assessment is flawed, its commitment to low inflation will be questioned for the second time in recent history. This would arguably have serious implications for holders of nominal bonds, more so than owners of inflation-linked assets.

David Hooker – Insight, a BNY Mellon company

Market pricing would suggest investors are anticipating a prolonged period in which inflation overshoots the Bank of England’s (BoE) inflation target. The BoE asserts any pickup in inflation is likely to be temporary. As market expectations and official inflation forecasts fall further out of sync, the reality that emerges will have significant implications for holders of nominal and inflation-linked bonds … read more

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Private equity: At the peak?

For yield-hungry investors, private equity has been one of the more attractive asset classes in recent years and it is unlikely to lose its appeal given the lower returns expected from more traditional investments over the coming year.

However, 2017 may offer some challenges. There are signs private equity may be near the top of the cycle: with valuations some consider stretched, deteriorating credit conditions and private equity firms struggling to put un-invested cash to work.

Although we expect private equity to continue to outperform public equity markets on a relative basis, investors may need to be more discerning – looking at more contrarian strategies: special situations, more illiquid strategies and those that are geographically diverse.

For investors who have so far focused on developed markets, the emerging markets could be a potential hunting ground. Private equity opportunities in emerging markets tend to be much less leveraged, operate in higher growth environments and valuations tend to be lower than in the public markets, meaning they do not look, in our opinion, as stretched as those in the US and Europe. Many businesses have also evolved over the past decade to be formidable competitors on the global stage.

Ralph Jaeger – Siguler Guff, a BNY Mellon company

For yield-hungry investors, private equity has been one of the more attractive asset classes in recent years and it is unlikely to lose its appeal given the lower returns expected from more traditional investments over the coming year. However, 2017 may offer some challenges. There are signs private equity may be near the top of the cycle: with valuations some … read more

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Could rising Chinese debt ruffle some feathers in 2017?

Even as we mark the beginning of the year of the rooster we believe China’s rising debt burden could ruffle some economic feathers in 2017. The consensus opinion remains that the leaders of the centrally controlled economy will continue to manage to ‘pull the right levers’ to keep GDP ticking along. Under the surface though, China’s sovereign balance sheet continues to deteriorate at an alarming rate.

The rate of credit expansion in recent years in China exceeds that of Spain and Ireland in the run up to their bubble peak in 2008, as well as that of the US during its mortgage boom and the increase in indebtedness in Japan during the 1980s. And although the starting point is very different from these earlier examples, at US$32tn, banking assets in China are now twice those in the US, despite the economy being 40% smaller. Furthermore, the misallocation of capital that has occurred is evidenced by the fact that continued strong increases in the use of credit have had less and less impact on growth – total social financing rose 11% year-on-year to November in US-dollar terms, but nominal GDP (measured in US dollars) increased by just 2% year-on-year in the 12 months to the end of Q3. We believe the contribution to world growth that has come from China means the potential for a greater slowdown matters not just for the Asian region but to economies and markets globally.

For more insight into what the next 12 months might hold for investors, please visit the BNY Mellon Markets 2017 special report.

Iain Stewart – Newton, a BNY Mellon company

Even as we mark the beginning of the year of the rooster we believe China’s rising debt burden could ruffle some economic feathers in 2017. The consensus opinion remains that the leaders of the centrally controlled economy will continue to manage to ‘pull the right levers’ to keep GDP ticking along. Under the surface though, China’s sovereign balance sheet continues … read more

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2016’s best and worst performers

The past year has presented something of an up-and-down ride for investors.

Despite a China-led sell-off at the start of 2016, equities over the course of the year benefited from a combination of central bank support and reduced volatility. A November/December rally was driven largely by events in the US and the perceived pro-corporate policies of President Trump. A lot of this optimism has now been priced in, especially for financials and the energy sector. Nevertheless, we retain a generally positive outlook for global equities on the assumption that central banks can continue to maintain the current stable policy environment. In the US this means slow but steady increases in the interest rate rather than sudden moves in either direction.

In commodities, there were two significant factors at play in 2016. In China, the ability of the Chinese Communist Party to engineer stability even in the face of decelerating growth was a crucial tailwind for demand. On the supply side, OPEC’s tentative agreement to curb production helped oil return to the US$50-a-barrel range, a level of support we expect to extend into 2017 assuming output can be curtailed.

In debt markets, a post-US election government bond sell-off was interpreted by some as part of a “great rotation” into higher risk assets. Nonetheless, we would note the sell-off was largely restricted to sovereign debt while niche areas such as inflation-linked bonds actually performed well. Looking forward, we would highlight long-term structural factors such as pension deficits and global ageing that argue for sustained demand for fixed income products.

Meanwhile, political risk remains key – with uncertainty over everything from US trade policy to rising Chinese capital outflows, European elections to the need for continued reform in emerging market economies.

Raman Srivastava – Standish, a BNY Mellon company

The past year has presented something of an up-and-down ride for investors. Despite a China-led sell-off at the start of 2016, equities over the course of the year benefited from a combination of central bank support and reduced volatility. A November/December rally was driven largely by events in the US and the perceived pro-corporate policies of President Trump. A lot … read more

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Why the time may be right for US financials

Brexit markedly lowered global growth and interest rate expectations. As a result, company managements for US Financials focused on cost-cutting and strengthening their balance sheets. We believe US Financials are the cheapest sector and growing the fastest. During third-quarter earnings season, 76% of S&P 500 companies beat earnings estimates. While the average beat was 5.6%, Financials beat estimates by 8%. Additionally, the third quarter was the first in over a year to show year-over-year EPS growth for the S&P 500, largely due the impressive 13% growth in Financials.

President-elect Trump could add additional fuel to the fire. If he deregulates the Financials sector, it could remove a massive growth overhang. Expansionary policies, like increased fiscal spending, could also encourage rate increases. Financials are largely domestic and would benefit most from corporate tax reform, with estimates that a 20% federal corporate tax rate would drive earnings higher by approximately 18% on average. After undue punishment since the financial crisis, headwinds are turning to tailwinds, and we believe US Financials are fundamentally stronger, undervalued and poised for a comeback.

For more insight into what the next 12 months might hold for investors, please visit the BNY Mellon Markets 2017 special report.

John Bailer – The Boston company, a BNY Mellon company

Brexit markedly lowered global growth and interest rate expectations. As a result, company managements for US Financials focused on cost-cutting and strengthening their balance sheets. We believe US Financials are the cheapest sector and growing the fastest. During third-quarter earnings season, 76% of S&P 500 companies beat earnings estimates. While the average beat was 5.6%, Financials beat estimates by 8%. … read more

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M&A: boon or burden?

One important challenge for corporate bond investors in 2017 will likely be a continuing rise in idiosyncratic credit risks in investment grade markets. A significant contributor is a wave of M&A activity, which often benefits a company’s shareholders at the expense of its bondholders. In a low growth environment, management teams struggle to deliver shareholder growth organically and so M&A or shareholder buybacks become a natural solution. However, this usually leads to an uptick in leverage ratios, which is a risk for credit investors.

Issues surrounding corporate governance are another factor. Examples include last year’s Volkswagen scandal and this year’s controversy surrounding Deutsche Bank and the US Department of Justice.

That said, we do expect stable, positive economic growth across the US and Europe next year and this should create a supportive environment for credit. At the same time, some of the tailwinds that drove the asset class in 2016, notably the ECB’s corporate bond purchase programme, are likely to fade away, and we are mindful of that.

For more insight into what the next 12 months might hold for investors, please visit the BNY Mellon Markets 2017 special report.

Lucy Speake – Insight, a BNY Mellon company

One important challenge for corporate bond investors in 2017 will likely be a continuing rise in idiosyncratic credit risks in investment grade markets. A significant contributor is a wave of M&A activity, which often benefits a company’s shareholders at the expense of its bondholders. In a low growth environment, management teams struggle to deliver shareholder growth organically and so M&A … read more

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Weeding out new opportunities

Prior to the recent US election, I believed that the significant grassroots support for legalisation of marijuana meant that its legalisation at a federal level was only a matter of time.  And in fact, the recent voter approvals in eight states reaffirm that the population as a whole would likely support such a move.  However, the recent announcement of Jeff Sessions as President-elect Trump’s candidate for Attorney General means Federal legalisation is no longer just around the corner.  As recently as April 2016, Mr Sessions was quoted as saying that “Good people don’t smoke marijuana”, so it is unlikely to be legalised under his watch.

I think that the tobacco industry is likely to be the most interested in marijuana as a source of future growth, with many companies already giving serious consideration to the crossover potential with vaping. But until it is legalised at a federal level, nothing can be done. Nevertheless, support among the general population is growing, and like gay marriage, we think it may be a case that over time overwhelming public support could sweep away previous social norms.

As for other international markets, moves are afoot to legalise marijuana for medical or recreational use in a variety of countries, including Canada, Germany, Israel, Mexico and Italy.

Watch this space.

Rosie Bichard – Newton, a BNY Mellon company

For a longer (pre-US election) article on this topic, head to Newton’s blog

Prior to the recent US election, I believed that the significant grassroots support for legalisation of marijuana meant that its legalisation at a federal level was only a matter of time.  And in fact, the recent voter approvals in eight states reaffirm that the population as a whole would likely support such a move.  However, the recent announcement of Jeff … read more

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Is the outlook for US financials brighter?

The vote for Brexit markedly lowered global growth and interest-rate expectations. As a result, company managements for US financials focused on cost-cutting and strengthening their balance sheets. We believe US financials are the cheapest sector and growing the fastest. During the third-quarter earnings season, some 76% of S&P 500 companies beat earnings estimates by around 5.6%, Financials beat estimates by 8%. Additionally, the third quarter was the first in over a year to show year-over-year EPS growth for the S&P 500, largely due the impressive 13% growth in financials.

President-elect Donald Trump could add additional fuel to the fire. If he deregulates the financials sector, it could remove a massive growth overhang. Expansionary policies, like increased fiscal spending, could also encourage rate increases. Financials are largely domestic and could benefit most from corporate tax reform, with estimates that a 20% federal corporate tax rate would drive earnings higher by approximately 18% on average. After undue punishment since the financial crisis, headwinds are turning to tailwinds, and we believe US financials are fundamentally stronger, undervalued and poised for a comeback.

John Bailer – The Boston Company, a BNY Mellon company

The vote for Brexit markedly lowered global growth and interest-rate expectations. As a result, company managements for US financials focused on cost-cutting and strengthening their balance sheets. We believe US financials are the cheapest sector and growing the fastest. During the third-quarter earnings season, some 76% of S&P 500 companies beat earnings estimates by around 5.6%, Financials beat estimates by … read more

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