2016 was a year shaped by surprises and drastic changes in sentiment. How investors feel about the economy is what’s reflected in prices. While major equity markets had a generally positive 2016 – driven by strong US economic data and improving conditions in Europe – there was a lot of global negativity for equities going into the year, fueled by China’s slowing economy, dropping oil prices, and geo-political uncertainty. Investors had more cash parked on the sidelines than ever before. However, major equity markets had a positive 2016 climbing the walls of worry, mainly driven by strong economic data out of the US (jobs, in particular) and improving economic conditions in Europe.
While most of this cash still remains on the sidelines, investor sentiment has been positive following the Trump nomination, with investors anticipating less regulation, low taxes and more spending.
This has pushed many global indicies up over 10%, and 10-year bond yields up nearly 0.6% in Canada and the US. Again, what is reflected in prices is what the market expects to come. The expectations of growth and increasing interest rates are priced in like they’ve already happened. If there is anything we can learn from 2016, it’s that we can’t predict the future.
Here are a few key things that shaped 2016 and have lined us up for 2017:
Despite several rate increase expectations, the Fed was forced to tread lightly as global markets were shaken repeatedly by unexpected events such as the Brexit and the political tension between Russia and Ukraine. Similarly, the Fed is currently indicating 3 rate hikes in 2017. Compared to historic levels, interest rates are still low, but we don’t believe the Fed can continue increasing rates for much longer, since most other major economies are still on the path to economic recovery.
In Canada, 10-year yields have moved in step with US treasuries, even though Canada’s housing market and future growth opportunities don’t appear as solid as in the US. This will put downward pressure on interest rates here in Canada.
Compared to other major global currencies, the USD fared well. Weakness in Europe stemmed from the Brexit vote and a shaky forecast for the EU. The Chinese yuan declined due to lower growth expectations. The Canadian dollar was one defector as rebounding oil prices pushed CAD higher.
Momentum is continuing to drive the US dollar up. However, increases will also face headwinds, because a US dollar that’s too strong could hurt exports and corporate earnings, as a significant number of US corporations earn a majority of their revenues in the global markets.
Demand for risky assets
Expectations for the “Trump Bump” are very high since his administration is expected to be more ‘corporate friendly’ (lower taxes and regulatory burden). That being said, policies like increased public spending don’t pass through Congress unscathed, and it’s likely what was promised on the trail in 2016 will not be what comes out of 2017. The US economy that Trump finds himself with has been plagued by sluggish productivity and an ageing population. Just like it’s not easy to change the course of a large ship, it will likely be some time before we see any policy changes come to fruition.
With most major economies on the path to recovery, we believe equities will continue to perform better than bonds, barring any significant unexpected events. However, we should bear in mind that periods of volatility will spring up from time to time, given some of the ongoing geo-political tensions. As a result, expected longer-term portfolio returns continue to remain in the 5 to 8% range depending on the risk appetite.
When the road ahead is unclear, our best course of action is to react to any swings in a systematic way. Our approach is to rebalance to our target in times where certain sectors outperform others, which has been the case lately. It may seem counterintuitive to sell funds that are outperforming to buy those which are underperforming, but history has shown that some of the worst declines have led to the best opportunities. Those who don’t rebalance miss out on these opportunities and often end up with a riskier asset mix than was originally targeted.