Markets driven by politics
2016 was a volatile year for financial markets, notably due to two major political events: the Brexit referendum at the end of June and the election of Donald Trump as President of the United States in early November.
2017 will also herald important political milestones – and these could trigger uncertainty and a surge of volatility on the markets. First, the elections due to be held in the Netherlands but also in France, Germany and probably in Italy. Then, the likely invocation of article 50 by the British government which will set into motion the UK’s withdrawal from the European Union. And finally, in the U.S., the Trump administration will take office and implement its first measures.
The “end of an era” for interest rates and bonds
Interest rates seem to have reached a major turning point during the summer of 2016, no doubt signalling the “end of an era” after a 35-year long decline in yields and an equally long bull market for bonds. This uptick in interest rates, driven by stronger growth and higher inflation expectations, should continue into 2017.
Particularly as the highly accommodating monetary policy orchestrated by central banks for a number of years – with mixed results - should gradually normalise. After a largely anticipated interest rate hike due to take place in December, the U.S. Federal Reserve should continue to raise its key interest rates gradually over the course of next year. On another hand, the European Central Bank is expected to begin withdrawing from its quantitative easing and asset purchase programme during the second half of 2017, in light of higher inflation expectations.
Strong sector rotation on equity markets
As far as stock market returns are concerned, 2016 has also been a year of wide swings and sector performance disparities. From July, higher forecasts for inflation, economic growth and interest rates ushered in the strongest and fastest sector rotation observed since 2009. This move saw financial, cyclical and commodity-related sectors rebound strongly, while more defensive and interest-rate sensitive stocks (telecoms, utilities, real estate, food and beverages) suffered a severe correction.
Among defensive industries, only healthcare showed some resilience, as Hillary Clinton’s defeat eased investors’ fears over possible pressure on drug prices in the United States – concerns that had weighed heavily on the sector in the months leading up to the election. This sector rotation could carry on in 2017, particularly if interest rates rise any further. However, much of the valuation gap between different sectors has already been filled.
A possible upswing for corporate earnings and European equity markets
European equity markets remain reasonably valued with prices in line with long-term historical averages; however the market offers no significant discounts (even if valuations are attractive relative to other asset classes). Corporate earnings growth will therefore be a decisive factor for an equity bull market next year and 2017 could (at last) be a positive turning point for European companies’ earnings, which have been contracting for 5 consecutive years.
Corporate earnings growth will therefore be a decisive factor for an equity bull market next year
Admittedly, as is the case every year, earnings growth forecasts are relatively high for 2017 – up by over 10%. But if financial and commodity stocks are excluded, the pace of growth is down to a more reasonable 5-7%. Furthermore, stronger inflation, the implementation of supportive fiscal and budgetary policies, and finally, robust advanced economic indicators in the Eurozone and in the United States (buying intentions in industry and services, consumer confidence, construction indices) all constitute favourable signals and drivers that could support earnings growth for European companies in 2017. Finally, while sector valuation discrepancies have tended to fade in recent months, valuation gaps between stocks within the same sector remain significant and close to their historic highs – providing an environment that is conducive to stock picking.
Without attempting to read the future or anticipate market movements and sector/style rotations, we do believe that active, conviction-driven and benchmark agnostic investing, based on the selection of quality stocks that are trading at a discount relative to their intrinsic value, is the best way (or is at least our way) to deliver sustainable long-term returns.
The opinions and estimates given represent our judgement and may change without prior notice; the same is true of statements regarding financial market trends, which are based on current market conditions. We believe that the information provided on these pages is reliable; however, it should not be considered exhaustive. The data, images and citations contained have been calculated or produced using publicly-available information that we believe to be reliable but we have not independently verified. Please note that all forecasts have their own limitations; consequently, Sycomore Asset Management assumes no liability as to their materialisation. This publication is not intended to be an offer or solicitation to buy or sell any financial instrument whatsoever. References to specific securities or to their issuers are for illustrative purposes only and should not be interpreted as recommendations to buy or sell.