Mark Lister, 21 December 2016

Over recent years, central bankers have had markets hanging on their every word, reacting to even the slightest change of tone. We believe the effectiveness of central banks will be much more limited from here, and that politics could displace central banks as the key focus for many investors. With this is mind, we outline our investment themes for 2017 below.


1. Politics likely to be an important driver for markets

Over the next few years, it might well be politics, as well as geopolitical risk generally, that takes centre stage as a key macro driver for financial markets.
The last 12 months have been relatively volatile for markets.

There have been a couple of specific events that have driven this – most notably the Brexit decision in June and, more recently, the US election. Brexit caught markets by surprise and the high volatility immediately afterward reflected this. But if markets thought that was a shock, they were well and truly stunned when Donald Trump emphatically beat Hillary Clinton in the US election, with the Republicans serving up a crushing victory over the Democrats.

There is no shortage of important political events on the 2017 calendar and we expect this trend of volatility to continue as they unfold.

We could see more regular bouts of volatility as markets fret over what could go wrong, and even if the general trend is up, it is likely to be a bumpier ride.

Action point: Make sure you are well-diversified across asset classes, geographies and sectors. Stick to high quality fixed interest and blue chip shares.

2. Inflation shows signs of life

Inflation, a traditional enemy of investment and returns, has been noticeably absent during recent years. While we don’t envisage a quick return to the high-inflation period of years past, 2017 could be the year we see it begin to make a comeback. We have seen a few early signs of this just recently.

3. Interest rates appear to have passed their lows

Interest rates around the world spent most of 2016 testing new record lows. In New Zealand, mortgage rates have been the lowest in decades, while the six-month term deposit rate declined to 3.1% (the lowest since 1965).

This has been a positive for borrowers, while fixed interest investors and prudent savers have been the losers. It has also meant that investors have flocked to anything with a yield as they look for alternative sources of income. This has had the effect of fuelling house price rises, as well as boosting

share prices for high-dividend paying companies.

However, we have seen the tide begin to turn with longer dated bond yields moving higher over recent weeks. While rates are highly unlikely to return to historic levels anytime soon, they appear to have passed their lows and could drift higher over the course of 2017.


4. 2017 could be a better year for growth shares

The International Monetary Fund (IMF) is forecasting global economic growth to slow to 3.1% in 2016, before recovering to 3.4% next year. The recovery is projected to pick-up as the outlook improves for emerging markets, and the US economy regains some momentum. In the US, a recovery in investment is projected, as is a fading drag from inventories. IMF forecasts suggest US growth will pick-up from 1.6% this year to 2.2% in 2017, while emerging market growth will rise from 4.2% to 4.6%.

On the other side of the coin, Europe, Japan and the UK are expected to see growth slip. None of these regions are expected to see negative growth, but momentum is forecast to slow.

Here in New Zealand, the RBNZ is forecasting GDP growth of 3.7% in the year to March 2017, and 3.6% in the 12 months after that. Even if these growth forecasts are negatively impacted by the recent earthquakes, we still expect the New Zealand economy to deliver robust growth.

The IMF has noted the potential for setbacks to their outlook is high, something that is reflected in repeated markdowns in growth during recent years. It is also unclear how the US outlook will change under Donald Trump. For now, markets are expecting many of his policies to be positive for economic growth, but it remains to be seen how these will be implemented and whether they will deliver as expected.

The impact on other parts of the world is equally uncertain. A more protectionist stance could see improved US growth come at the expense of other parts of the world, most notably emerging markets. Ironically, this could drag global growth down and, to a degree, impact the US as well.

On balance, and despite these risks, it could well be a reasonable year for growth companies. The yield on longer-dated bonds are well off their lows, and this could make for a challenging environment for high-yield companies. While they offer attractive dividends, investors will be less willing to pay high prices for these as alternatives (such as fixed interest and bank deposits) are now offering more reasonable returns.

If growth, inflation and interest rates are going to be higher than we have seen in recent years, companies with lower yields but more attractive growth prospects will be the beneficiaries. We recommend investors ensure they have a healthy allocation to high quality companies with strong growth options.

5. New Zealand is in great economic shape, but don’t get complacent

The domestic economy has been firing on all cylinders in 2016.

Economic growth was 3.6% in the year to June, the strongest since 2014 and the envy of the developed world. Migration is still hitting record highs, unemployment has fallen below 5% for the first time since 2008, and business confidence remains robust.

Dairy prices have risen more than 50% since July and are at their highest levels since June 2014. Fonterra last month lifted the payout to $6.00 (before dividends), which is significantly higher than last year’s $3.90. This means the average farmer will be above breakeven for the first time in three years.

It is encouraging that the economy has grown at its fastest pace in more than two years while a key export sector like dairy has been in an unprofitable position. This bodes well for 2017.

However, we shouldn’t get complacent. It is possible that things are close to ‘as good as they get’ for the local economy. The very strong house price gains over the last few years will have certainly had a positive impact on many sectors, as well as consumer spending and activity levels. Further, house price gains in the region of 10%+ pa are unsustainable, so from here we might need to see genuine productivity growth, which is much harder to come by.

We also need to remain cognisant that we are a small, vulnerable economy that is still highly dependent on our primary sector. As such, investors must ensure they are well-diversified across other markets, if only as an insurance policy against ‘New Zealand risk’.

6. The worst is over for commodities, but don’t rush in just yet

Oil and commodities have been a minefield for investors over the last few years. The oil price sat comfortably around US$100 from 2011 through to early 2014, before collapsing and ultimately going as low as US$27 in February of this year. There were numerous reasons for this including oversupply, weaker demand from some regions, as well as other factors unique to specific commodities.

This volatility has flowed through to mining and resources companies, as well as those servicing the industry. A key reason for the underperformance of the UK and Australian markets in recent years is the heavy dominance of mining companies (as well as banks, which have been under pressure for different reasons).

Since February, commodities have made somewhat of a comeback. Similar to what we have seen with dairy prices, the oil price has rebounded into a trading range of approximately US$40-50, while other commodities have also been strong in recent months. Iron ore, Australia’s biggest export commodity, is currently back at levels not seen since April.

We believe the worst is likely over for oil and commodity prices. However, we also expect any recovery to be volatile, punctuated by sharp rallies that eventually fade, before the cycle repeats.

This article was originally published in the December 2016 issue of News & Views.