Black swans and bonanzas for 2017
LONDON (Reuters) – Looking at what 2017 may hold for markets, the broad view among investors is that the 35-year bull run in bonds is over, inflation is back and central banks are maxed out.
Also, for the first time in a decade, any stimulus to the global economy will come from governments.
That – after a year in which politics, economics and finance were turned on their head – suggests bets on further increases in bond yields, developed world stocks and the dollar. Emerging market currencies, stocks and bonds are meanwhile expected to struggle under the weight of higher US bond yields.
Cyclical equities are favored over defensives, banks should benefit from steepening bond yield curves, while infrastructure spending could boost housing and construction stocks.
That’s the consensus. But what goes against the grain and catches the eye? Where might the wrinkles appear?
1. Bond yields to fall?
HSBC, which correctly called the recent slide in US bond yields to historic lows, says bond yields may well rise next year and expects 10-year Treasury yields to hit 2.5%.
But only in the first quarter. After that, HSBC’s bond strategist Steven Major reckons they will fall back to 1.35% because 2.5% would be unsustainable under tightening financial conditions, dragging on the economy and constraining the Fed. A bold call.
2. US 10-year yield at 4%?
“Forget the boring old investment bank research for 2017; find out what the greatest minds of City Index think are the best trading opportunities for the year ahead!” They certainly don’t hold back: Stocks get “slammed” as the end of the bond bull run “starts to bite” and pushes 10-year US Treasury yields to 4%; And the oil producers’ agreement to cut output falls apart and crude plunges to $15/barrel.
3. Four black swans
Economists at Societe Generale illustrate a graphic with four “black swans” that could darken the market landscape next year. The tail risks they see as most likely to alter next year’s outlook stem from political uncertainty (30% risk factor), the steep increases in bond yields (25%), a hard landing in China (25%), and trade wars (15%).
4. The ‘good carry’ in EM
Few dispute that a higher dollar and US yields next year will hurt emerging markets. Goldman Sachs expects both, but two of its top 2017 trade tips involve buying EM assets.
One is going long on an equally weighted FX basket of Brazilian real, Russian rouble, Indonesian rupiah and South African rand versus short on an equally weighted basket of Korean won and Singapore dollar to earn “the good carry.” The other is going long Brazilian, Indian and Polish equities.
5. $1 trillion US earnings bonanza
How much offshore earnings can US companies bring back if president-elect Donald Trump follows through with his pledge to cut corporate tax?
About $1t. , according to estimates by Deutsche Bank. This could give US stocks, already at record highs, another shot in the arm. Citi reckons global equities will rise 10% next year, led by developed markets. A 10% rise in the dollar and cut in US corporation tax to 20% could add 6% to global earnings per share.
6. Yuan over 8
Many FX analysts expect the Chinese yuan to continue falling, but few see it breaking on the weak side of 8.00 per dollar. Those at Deutsche Bank do, albeit not until 2018, though that would still mark a sizable fall next year for a currency tightly controlled by Beijing. A rising dollar is one side of the equation. And on the other, Deutsche reckons Beijing will not want to see reserves fall below $3t. , meaning capital outflows will hit the currency harder than the last couple of years when reserves have been used to cushion the yuan’s fall.
7. Bremain?
Here’s the scenario: Britain stays in the EU. Goodbye Brexit, hello Bremain. It’s highly unlikely, and analysts at Nomura don’t think it will happen. But it’s one of 10 potential “gray swan” events for next year they reckon investors should at least consider. “As 2016 was the year politics ‘stumped the consensus,’ why couldn’t 2017 do the same?”