Posted on: 15 December 2016
For financial markets, two key events defined the past year - June’s EU Referendum in the UK and the US presidential election in November. The results of both were not forecast by pollsters, demonstrating the difficulty in capturing significant regime shifts within population voting patterns. Despite expectations that voting to leave the EU and voting in Donald Trump as President would be negative for the UK and US economies, the equity markets of both confounded expectations by performing strongly through this year.
The UK votes to leave…
While the surprise of the referendum result has begun to fade, the longer term economic impact and lack of detail around the Brexit negotiations remain uncertain. This has put pressure on Sterling. At the start of the year the GBP/USD exchange rate was 1.47, hitting a low of 1.21 in October, a fall of 17.7%. The equity market has also suffered with UK large cap stocks falling sharply after the referendum result, but since rallying by some 23%. In the year-to-date the UK market is down 3.5% in US dollar terms despite a 14.0% rise in sterling terms. This shows the extent to which UK assets have been marked down by the international community, but also the high level of dollar revenues within the UK market, which will boost overall earnings. To a certain extent, this is irrelevant for UK-based private clients because they view the world in sterling. However, the first order impacts on the price of a foreign holiday and the price of imported goods show the real world effects of the drop in sterling. This may impact consumer spending next year, at the same time as the realities of leaving the EU become more apparent. To date, the competitive boost provided to the manufacturing sector has had little effect on sales, perhaps due to the measly growth rates within our major trading partners.
In August the 10 year gilt yield hit 0.52%, but then rose sharply to 1.25% in December as inflation expectations moved higher on the back of sterling’s sharp falls. This follows similar trends in the US, where inflation expectations moved up on the back of early responses to Donald Trump’s intentions to increase public spending on infrastructure.
During the course of next year, the prognosis for the UK’s post-Brexit economy should become clearer. Similarly, we should also see more evidence of Donald Trump’s policy agenda after he takes the Presidency in January, which may pour cold water on some of his more outlandish proposals to date.
…and the US casts more votes for Trump than Clinton
In the US, meanwhile, Donald Trump’s victory in the presidential election highlighted the wave of anti-establishment fervour and has challenged the whole concept of globalisation. After nervousness prior to the election, equity markets soared in response to Trump’s pro-growth agenda and promise to cut taxes. Despite the shock result, the US market has not fallen, but risen to hit new all-time highs, especially in anticipation of Trump’s fiscal stimulus plans. Unhedged sterling investors in the US have benefitted from both a strong performance in the equity market and a strong performance from the dollar.
While the rest of the world watches
Following a relatively flat start to the year, emerging markets have also benefitted from equity market strength. Investment opportunities abound in a number of regions, such as India which has a dynamic economy and is relatively well insulated from global capital flows. We believe it is important to treat each market on its own merit, rather than treating developing markets as a homogenous bloc. Japan has also held up thanks to improving sentiment towards Japanese monetary policy. The Nikkei has performed well, rising 11.5% since the day before US election results, as the market tends to move inversely to the currency and the yen has weakened versus the dollar.
There are many selective opportunities to shape portfolios for those investors with a longer-term investment horizon.
All that glitters
Given the uncertainty that framed the year we included gold in our investment strategy as a good inflation hedge and portfolio diversifier, especially as interest rates remain low and gilts are less able to provide portfolio insulation as they might historically have done.
As 2016 comes to a close…
Investors and the markets have adjusted to the significant events of this year and we are now entering the next stage of realising their impact. As we prepare for further elections in Europe, political instability and the prospect of rising inflation, the focus will be on positioning investment strategies to take advantage of opportunities that may emerge from further geopolitical changes.
All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the amount invested. Past performance is not a reliable indicator of future results.