2016 was certainly the year of surprises –with Brexit and Trump shocking the world. Yet, besides short-lived market sell-offs, global markets were relatively resilient. So what might be on the horizon for investors in 2017? William Nygren , Partner and Equity Manager at Harris Associates (Natixis Global Asset Management), explains his views about growth in 2017, answering three key qestions.
1. Anemic growth?
“For several years, we’ve been anticipating that global growth would return to near the pre- Global Financial Crisis levels. And each year the World Bank started out by projecting that reasonable growth was just around the corner. Then as the year progressed, they had to consistently cut their expectations. Low growth has allowed interest rates to remain at near-zero levels, has allowed commodity prices to remain below prices needed to justify new exploration, and has resulted in the earnings of cyclical companies being below trend”.
2. Growth momentum?
“If 2017 is finally the year when growth surprises to the upside, it would likely be accompanied by very different sectors leading the stock market. That is why we favor companies that may benefit from rising interest rates (banks and other financial companies), rising commodity prices (energy companies), and higher earnings from industrial cyclicals”.
3. Unknowns of Trump administration.
“The U.S. political scene will be of key importance in determining whether or not global growth accelerates. Throughout a very nasty presidential campaign, many policies were promised from the prevailing party that were both pro-growth and anti-growth. If the new Trump administration focuses on tax reform and reducing the burden from regulations, the result would likely be a meaningful increase in growth. If instead the focus is on restricting global trade and deporting illegal immigrants, growth would likely decrease”.
“We believe the likelihood is much higher that pro-growth policies will prevail, but would also add that over many years the forces of global growth have proven strong enough to overcome misguided government policies. As long-term investors, we believe the valuations are compelling for the companies that would most benefit from renewed economic strength”.
One surprise that could catch us off guard
According to the expert, a return to growth could create a very unpleasant surprise for many investors, as investments widely perceived as safe could be riskier than those perceived as risky. “Investors tend to look at the risk of a stock as being the potential deviation of earnings from the anticipated level, and pay little attention to price. We have been saying for some time that low-volatility businesses priced at historically high relative P/E ratios are riskier than higher-volatility businesses priced at low relative P/Es. With interest rates so low, the stable, low-growth businesses that pay out a high percentage of profits as dividends have become favorite “bond substitutes” for investors seeking higher yield than is available in the bond market. These companies have typically been priced at lower-than-average P/Es, but today sell at substantial premiums”.
“Even if the businesses perform about as expected, there is substantial risk should the P/E ratios revert to their long-term averages. If interest rates rise, as we expect, then P/E reversion is the likely outcome. This is why we currently find most electric utilities, telecom providers, or U.S.-based consumer packaged goods businesses unattractive.
Additionally, in a higher interest rate environment, stocks would likely prove less risky than the long-term bonds that investors have bid up to historically low yields. 2017 could be a year that turns investor thinking about risk upside down”.