Looking into 2017, our primary investment thesis is based on the belief that investors are underestimating the prospect of stronger growth and inflation in the US economy relative to the rest of the world over the next year.
Where’s the growth?
Global growth has been weaker than many policymakers and market participants expected following the 2008 global financial crisis. The deleveraging cycle in the developed world and the Chinese economy’s transition to a lower-growth path have both acted as major headwinds to the global economy. In response, central banks have undertaken extraordinary policy measures to provide support, which, in turn, have strongly in uenced the direction of asset prices.
Pessimism is in the price
We believe the global economy’s structural issues will remain with us for some years to come, resulting in a continuation of the low-growth environment. However, this has largely been accepted by investors. Looking into 2017, our primary investment thesis is based on the belief that investors are underestimating the prospect of stronger growth and in ation in the US economy relative to the rest of the world over the next year.
Following an easing of financial conditions over the past year, with government bond yields and mortgage rates having declined significantly, we see positive trends emerging in US credit growth and the housing market in particular. In our view, this implies higher longer-dated US bond yields and a stronger US dollar looking forward. As a result, we believe that many of the areas that have struggled through 2016 appear to offer some of the most attractive opportunities.
Sectors are diverging
The large decline in longer-dated government bond yields this year resulted in a meaningful division within equity markets. This has been particularly prevalent in the US market where, although the S&P 500 has made little overall progress, there has been a high level of dispersion in performance between those sectors that gained from lower bond yields and those that lost.
US banking bounce?
An example would be the performance of US banks relative to utility companies, with the former underperforming significantly. While a stronger US dollar and higher bond yields may act as a headwind to US equities more broadly, we believe there is scope for a rotation within the equity market and consequently we have been sellers of US utility companies and buyers of US banks.
We have also been sellers of government bonds and have been reinitiating long US dollar positions against the currencies of countries where we expect monetary policy to remain loose or even be eased further, such as the Korean won, Taiwanese dollar, New Zealand dollar and Japanese yen. With the exception of the latter, these currency positions are designed to act as defensive positions at a time when government bonds may struggle to perform.
Positioning for 2017: Flexibility is the key
Although we believe there are a number of compelling opportunities in 2017, we acknowledge that valuations across the majority of asset classes are not as attractive as they have been in recent years, as we remain in an environment of structurally low growth with economies more susceptible to shocks. As a result, the overall risk level of our strategies will likely remain lower than would otherwise be true, were risk premia to be higher, and we will continue to use our flexibility to identify opportunities as they appear and to seek to protect capital as risks emerge.
Iain Cunningham is a Portfolio Manager in the multi-asset team at Investec Asset Management.