INVESTING IN A TOPSYTURVY WORLD
INVESTING IN A WORLD WHERE ALL BETS ARE OFF
The global economy appears to have shrugged off 2016's political surprises, and growth is expected to pick up this year. But what are the unexpected events that investors should look out for in 2017?
if the political and economic dramas of 2016 have taught us anything, it is to acknowledge our occasional ineptness at accurately predicting the outcome of seemingly predictable global events. As some analysts, economists and observers nurse bruised professional egos following the widely unpredicted election of US President Donald Trump in November and Britain’s decision to leave the EU in June, attention now turns to the likely impact of these, and other, unforeseen events on the world markets in 2017.
In this “post-truth” global setting, international politicking and political manoeuvring will undoubtedly continue to sway the global economy in the year ahead, steering investment appetite and rendering the implications for different asset classes uncertain throughout the year.
Foremost on the risk monitor for investors and policymakers alike, Momentum Investments marketing head Steven Schultz cautions, is the evident mass disapproval of globalisation, which appears to have been portrayed by increasingly popular right-wing political parties as a “rigged system” created for the benefit of global elites.
Increased immigration and terrorism concerns could see intensified trade protectionism by states, reversing gains made during earlier landmark trade agreements that aimed to further assimilate the world economy.
A possible secular trend reversal in global interest rate policy and the potential end of the era of free movement of goods, capital and labour, could induce further instability in asset markets in 2017, Momentum head of asset allocation Herman van Papendorp tells finweek.
While the global economy appears to have shrugged off earlier unimagined political outcomes – most notably Brexit in June and Trump’s surprise victory in the US presidential election in November – through further stimulus and a swift response by central banks, the world economy is hardly in peak condition, he adds.
“While less austere budgets could temporarily boost growth, an increase in borrowing today by the public and private sectors risks narrowing growth prospects in the future.
“We expect a modest growth trajectory in developed economies over the medium term, with the UK and Japan remaining the laggards, while improving fundamentals and continued policy support should underpin relatively firmer economic activity in the US and eurozone, respectively,” Van Papendorp advances.
Schultz warns investors to watch out for further signs of the populist “anger” that has already swept through the West, and which would see additional eurozone states, such as France and
Germany, voting to divorce their European neighbours.
“The general feeling of disenfranchisement with current politicians should not be overlooked. A ‘Frexit’ [France exiting the EU], in an effort to retain monetary, legislative, territorial and budget sovereignty, while not the base case, could trigger a widespread crisis,” Old Mutual chief investment strategist Dave Mohr and Old Mutual investment strategist Izak Odendaal add in a recent investment note.
In addition to politics, investors should keep a close eye on the current bout of listless global growth. With world output expected to come in at around 3%, sluggish growth appears to be becoming entrenched as the new normal for the global economy.
Additional “known unknown” events that could influence investment markets in 2017, according to Van Papendorp, include:
Uncertainty about the probable differences between policy measures originally mooted by Trump while on the campaign trail and those eventually implemented by him as US president. Among these are the depth and magnitude of US fiscal stimulus and the repercussions of trade protectionism for inter-regional trade and its resultant impact on global growth.
The multitude of upcoming European elections in 2017 – including the Dutch, French and German general elections – which could extend the global trend of disestablishmentarianism that started with Britain’s decision to leave the EU and the election of Trump in 2016. These could increase the likelihood of an eventual break-up of the eurozone.
Britain’s initiation of its Article 50 divorce from the EU, or Brexit, could also cause some market volatility.
Policy decisions taken at China’s 19th Communist party congress during SA’s spring this year could impact global markets.
There are also unknown unknown events that could surprise markets in 2017, Van Papendorp says, including:
Geopolitical shocks beyond the known hotspots of the Middle East that could destabilise markets.
Financial crises that could originate
With world output expected to come in at around 3%, sluggish growth appears to be becoming entrenched as the new normal for the global economy.
from an unexpected source beyond China’s over-indebtedness or systemic failure of the European banking system.
As the US enters a year with political outsider Trump at the helm, investors are questioning whether “Trumponomics” will echo “Reaganomics” – the economic policies of former US President Ronald Reagan in the 1980s, which focused on the reduction of taxes, increased military spending and the deregulation of markets.
MMI economist Sanisha Packirisamy and Van Papendorp believe that Trump is now faced with the challenge of bridging the chasm between the rich and poor at a time when government’s debt-to-GDP ratio is closer to 100%, limiting fiscal headroom.
“Anticipated Trump stimulus could lengthen the current (already extended) business cycle, reducing the probability of a near-term recession. Potential tax and regulatory changes are likely to boost confidence and rekindle investment. There is, however, great uncertainty attached to how much of Trump’s agenda will become a reality,” the duo state in a recent 2017 economic outlook.
Should Trump enter into major trade conflicts with key trading partners, the US economy could be faced with onerous countermeasures that could weigh negatively on growth.
“A disruption in trade between the US and China, in particular, could have dire consequences for the rest of the world,” they caution.
Recent calculations by the International Monetary Fund have found that, should the US levy tariffs on China and they retaliated, growth would be 0.2% lower in the US and both imports and exports would drop by 2%. If worldwide tariff and non-tariff barriers increased so that import prices rose 10% over three years, global growth would plummet by 2%.
Crossing the pond, analysts anticipate a slow, drawn-out exit from the EU by Britain, with the exiting sovereign likely to struggle with further rises in domestic prices and weaker growth.
“Although the prospect of Britain leaving the European Union undeniably presents the latest in a rolling series of crises in the region, the economic damage will be negligible for most countries,” says Schultz.
Apart from the need to reach a deal on a financial services treaty with the EU, Packirisamy and Van Papendorp outline that the UK will need to negotiate treaties with the 52 countries that the EU currently has agreements with, which could force a transitional deal to keep trading terms unchanged for several years even after a formal Brexit in 2019.
The SA scenario
Domestically, growth in South Africa is set to improve marginally in 2017.
Agricultural output is estimated to recover owing to higher rainfall, while exports are likely to piggyback off slightly better global economic activity and a modest revival in commodity prices.
“Restocking in response to higher growth expectations could lift growth to above 1% in 2017,” Packirisamy and Van Papendorp suggest.
Nonetheless, the duo cautions that growth is likely to remain sluggish as a result of political uncertainty ahead of the ANC’s National Executive Committee (NEC) elective conference in December.
“South Africa’s temporary avoidance of a rating downgrade, coupled with peaceful municipal elections last year and demonstrated resilience of key institutions, has made it clear that all is not lost for South Africa just yet.”
The meeting is considered the next important indicator of SA’s political direction following the ANC Policy and Consultative Conference in June.
“Though lower food inflation and a probable shift to looser monetary policy in the latter half of 2017 should provide some relief to consumers, households remain exposed to a bleak jobs outlook, high levels of indebtedness and the potential for higher taxes.
“Based on our forecasts for headline inflation to drop more meaningfully on a two-year outlook, we expect further interest rate cuts in 2018 to benefit consumption spend further out.”
Dodging the downgrade
South Africa again enters a new year with the lingering threat of rating downgrades by the world's major agencies. While the country has – for the time being – dodged the downgrade bullet by Standard & Poor’s (S&P), Fitch and Moody’s, all three have placed SA on a negative outlook, keeping the sovereign rating unchanged above noninvestment grade.
Amid strong fears that S&P would slash the country to junk status when it published its report on South African debt late last year, the rating agency kept the rating of government’s foreign
currency-denominated debt on the lowest investment grade notch at BBB-.
However, as expected, S&P downgraded the local currency rating by one notch to BBB.
A week earlier, Fitch announced that it had dropped the outlook attached to its BBB- rating of South African debt to negative from stable. Moody’s issued a report on the same date without any changes to the sovereign credit rating at Baa2, two notches above sub-investment grade, with a negative outlook.
While Sanlam Private Wealth equity analyst Renier de Bruyn believes SA needs to implement structural reforms to improve the long-term growth potential of the economy, he calls for optimism following the “encouraging” ratings outcome towards the end of what had proved to be a tumultuous year on many fronts.
“Most economists polled in the first half of 2016 agreed that a fall to junk status seemed inevitable. Given all the political turmoil both locally and abroad, South Africa’s temporary avoidance of a rating downgrade, coupled with peaceful municipal elections last year and demonstrated resilience of key institutions, has made it clear that all is not lost for South Africa just yet,” he asserts.
De Bruyn cautions, however, that the most recent spate of decisions by the rating agencies were merely a temporary stay of execution.
Together with political challenges to domestic policy implementation, negative developments in US-China trade relations and its impact on commodity prices act as key downside risks to SA’s potential growth profile.
“As such, we see a strong chance of a foreign rating downgrade by S&P to sub-investment grade by June. During this timeframe, Fitch is likely to maintain their negative outlook, while there is a high probability that Moody’s could downgrade its more optimistic Baa2 rating by one notch,” Packirisamy and Van Papendorp predict.
Herman van Papendorp Head of asset allocation at Momentum
The UK will need to negotiate 52treaties with the countries that the EU currently has agreements with, which could force a transitional deal to keep trading terms unchanged for several years even after a formal Brexit in 2019.
Sanisha Packirisamy Economist at MMI