Without question, 2016 was the year of the big surprise. Or to be more accurate, surprises.
The biggest surprises were the Brexit decision in late June, when—despite all expectations to the contrary—the UK electorate voted to leave the EU, sending markets into a tailspin for a few days while pushing sterling lower. Then, just when markets appeared to have regained their footing, the US electorate provided the next, possibly even bigger curveball—the unexpected election of Donald Trump as 45th President of the United States.
Perhaps not a bombshell by the time it occurred, but nevertheless surprising in light of how long it took to play out, the Fed finally raised interest rates at the end of 2016, only the second time it hiked since 2006, after indicating at the end of 2015 that four hikes would probably occur in 2016.
It was an eventful year for markets from the outset. On January 4, the sharp selloff of the Shanghai Composite continued the meltdown that began in mid-2015. It was driven by fears of a slowdown of China’s economy and additional yuan devaluation. Though government intervention stanched the bloodletting, it’s been a roller coaster ride for Chinese markets throughout 2016.
February brought an additional shocker: crude oil prices hit their lowest level since May 2003—$26.21bbl. Mid month the Dow was down 10% on the year.
Both the commodity and the benchmark index have recovered nicely. Currently crude is priced at around $53.00, while the Dow, having already reached a number of all-time highs over the course of the year, now sits just a hair below its next record—the hallmark 20,000 level.
Gold, which many assumed would be a major beneficiary of such risk events as Brexit, as investors and traders went in search of safe havens immediately after election results were announced, hit its 2016 high during July, $1,364. Many predicted a new bull market for the Precious Metals complex, but the baby bull faltered and as of this writing appears to have died….at least for now. Gold is currently trading at around $1,130, its lowest level in 11 months.
There were some serious surprises in FX markets as well. The U.S. dollar looked to be weakening as 2016 commenced, with the US Dollar Index hitting its 2016 low of 92.62 on May 2. But as events during the second half of the year played out, king dollar reasserted its strength; the DXY is currently hovering around 103.00, a level not seen since December 2002.
The GBP and EUR didn’t fare nearly as well. The pound is currently trading at 1.2277 vs the USD, not far from a 31-year low of 1.2020 touched in the immediate aftermath of the Brexit vote. The euro is hovering at a 13-year low of $1.0456 though analysts predict there’s USD parity in its near future, possibly followed by a fall below that benchmark.
As questions regarding when Article 50 might be triggered continue to dominate the conversation, we asked a number of our most popular contributors to tell us how they believe markets will perform into 2017.
Michael Hewson: Bond Market Sell-Off, Higher Yields, Pound Declines
For the last few years, central bankers have tried in vain to jump start the inflation fairy with little if any degree of success.
For a while in the months after 2009 we did see a sharp rise in commodity prices in the wake of a weaker US dollar, but this proved to be somewhat short-lived, as from 2011 chronic overcapacity saw these gains unwind over a five year period, prompting concern that the world was going to hit a long period of deflation.
Over a period of five years the Reuters CRB Index dropped from highs of 370 in 2011 before finding a base of 155 earlier this year, a decline of 58%, helped in no small part by significant declines in oil prices to multi year lows along with a fall in broader soft commodities as well.
This period of overcapacity in the commodity sector appears to be drawing to a close and the lagging effects of falling prices are now starting to fall out of the inflation numbers. This transition started to manifest itself at the turn of the year, just before commodity prices formed a base in the first part of this year.
Rising debt levels alongside an extended period of government fiscal retrenchment also helped put the brakes on prices, while central bank determination to keep the cost of borrowing low helped fuel a bond market rally that does appear to now be showing some signs of tiredness.
The election of Donald Trump as US President in November could well be the catalyst that prompts the end of this decades long bull market in bonds, and a potential turn in the low interest rate cycle.
While many a bond trader has ended up getting burnt in trying to call a top in the bond market in the last few years this time could well be different, though I’m also sure these words were also uttered on previous occasions where traders were tempted to call the top.
In the last few months there does appear to be some evidence that this may be about to change, though particularly since we are now starting to get the first signs of a turnaround in inflation.
In China we’ve seen producer prices move sharply into positive territory for the first time in over 5 years, while inflation in the US, EU and the UK has been trending higher for the best part of this year.
In the UK we’ve also seen a sharp rise in factory gate prices, and while a lot of that is down to the decline in the pound in the wake of the Brexit vote, inflation was already trending up prior to the vote in any case.
Inflation expectations are already up sharply since the summer with UK 5Y5Y at 3.575%, its highest level since mid-2013, while in the EU we’ve seen the same indicator move from lows of 1.25% in the summer to 1.715% now.
In the US the same measure has jumped from lows of 1.792% to 2.457%, which if you measure it against the current level of yields on UK, US and German debt means that yields have room to go quite a bit higher.
If 2016 has been a year of surprises, then 2017 could well be the year of a bond market sell-off and higher yields, particularly since UK gilt markets and German bund markets are also showing similar signs of weakness.
Time will tell, but the omens for higher yields look ominous, particularly since central banks want a steeper yield curve.
Kathleen Brooks: Oil To $15bbl, RBS Broken Up, GBP/USD To $1.18
King Dollar
We expect the US dollar to be the best performer in 2017. EUR/USD parity is on the cards, we could see back to 120.00 in USD/JPY, and potentially back to 1.18 in GBPUSD. The driver of this move in the dollar include: US rates continue to rise, a banking crisis in Europe, along with rising political risk and a narrow loss for Marine Le Pen in France’s Presidential election in May, which boosts Europe’s hard right movements and threatens the future of the EU. As US yields rise to 4%, it looks like nothing can stop the US currency. The only problem: the US trade deficit has exploded, at the same time as fiscal largesse is pushing up US government borrowing to unsustainable levels, leading some, including China, to start questioning the benefit of buying US Treasuries. The dollar rallies until Trump gets in the way, refer below.
10-year US Treasury yields rise to 4%
Equities get slammed as the end of the bond bull run starts to bite. Rising yields lead to a very uncomfortable year for some emerging markets, including Turkey, which has an unsustainable US dollar debt position. The EU comes to its rescue with a loan, leading to a rekindling of EU/ Turkish relations, by the end of 2017 Turkey is on track to join the EU. Political upheaval in Turkey leads to the ousting of as President Erdogan, this time without the need of a coup, as economic conditions in the country deteriorate.
Oil Falls To $15 Per Barrel
Iran and Saudi both renege on their plans to cut oil production in 2017, which in turn leads to the break down of the OPEC consortium. Russia distances itself from its previous plan to cut production by 600,000 barrels, leading to a massive oil glut. President Trump steps in to protect the US’s oil and shale gas industry, as the US becomes the first oil producer to guarantee oil companies a minimum price for a barrel of oil, thus increasing the size of the US’s balance sheet even more.
US financial stocks are best performers on the Dow
The first half of 2017 is positive for US banks as they continue to retrace their financial crisis losses on the back of the ‘Trump effect’. Plans to scrap the Dodd-Frank rule, easing regulation for the banking sector, along with an uptick in the US economy, are powerful drivers for the US banking sector, which continues to look in far better health than its European counterpart. At some point in H1 2017 we expect the Dow Jones Banking sector to return to its 2014 highs. However, the second half of 2017 is a trickier time for financials as the markets question whether Trump’s policies can deliver the long-run growth he has promised.
Trump impeachment by end of 2017
One tweet too far from President Trump leads to him being ousted by an angry Congress, representing both sides of the political isle. Don’t rule this one out; after all, 2016 delivered some of the biggest political shocks in a couple of generations. Teflon Trump comes unstuck after one controversy too many, which leads him to impeachment. The US political system is thrown into disarray, as Vice President Pence takes the reigns of power. With Trump out of the frame, fiscal largesse takes a back seat, leading to reduced expectations for US growth in 2018 and 2019, and the end of the global rally in equities.
Break Up Of RBS (LON:RBS)
Having followed RBS for almost a decade, I now agree with an authoritative minority that believes it is impossible to turn the bank around, and that it should be broken up instead. Liquidating RBS won't be easy. But it will be preferable to further consecutive annual multimillion losses. How the bank is broken up is less important than marshalling the political will to do it. Right now, political expediency, rather than Britain's best interests seems to be the main reason why two Chancellors have opted to let RBS battle on.
George Osborne got closest to biting the bullet. In the end he decided on an 'internal bad bank'. The "effort, risk and expense involved in the creation of an external bad bank is not justified", to quote from the outcome of the review he commissioned. The problem for RBS is that its problems keep mounting. On the legal front alone, a rough tally of penalties, settlement costs, and, where known, provisions, for litigation coming to a head over the next two years, comes to around £20bn. And that's barely scratching the surface.
On top of that, RBS failed the Bank of England's latest simulation, partly because risk regimes are converging towards international norms like “Basel III". Under these, provision requirements could revert closer to RBS's previous five-year rate of 2% per Risk-Weighted Assets (RWAs), than 0.1%-0.2% currently. With RWAs forecast at £275bn this fiscal year, in theory provisions would be £5.5bn at the higher rate. Yet, in an era of bank decapitalisation, RBS's RWA reduction will remain slow.
A break-up doesn't have to be a wholesale slaughter. Economically enhancing solutions abound. One proposed by the New Economics Foundation in 2014 foresaw the creation of a network of 130 locally run banks, saving costs by using RBS's centralised back-office systems. Another full-year report underlying RBS's dearth of progress will lift the matter higher up the political agenda. The breakup of RBS could begin sooner than later, Chancellor Philip Hammond may even begin to signal his views as soon as his Spring Statement.
Tesco Claws Back Market Share From Aldi And Lidl
Tesco (LON:TSCO) is about to flex its muscles and remind discounters that low-low prices aren’t everything in Britain’s grocery world. The latest independent industry data shows Tesco, still Britain’s biggest supermarket, pulling ahead of rivals again by means of both lower prices and finely calibrated store refinements. This led to Tesco volumes rising 2.2% year-on-year over 12 weeks to 6th November, the fastest pace for three years, according to researcher Kantar Worldpanel. It comes after Tesco reported three straight quarters of underlying sales growth in its main British market. October’s Kantar report also showed Tesco growing UK market share for the first time in five years.
The revamped Tesco under CEO David Lewis is riding back to strength on a strategic shift towards more of its own label products. Cheaper "Farm Brands", launched in March, are encouraging shoppers to return from discounters Aldi and Lidl, as is the more upmarket "Finest" range. Kantar noted more affluent shoppers returning to Tesco, from Waitrose and Marks and Spencer (LON:MKS). By contrast, last month, sales growth at the discount upstarts continued to stall and hit the slowest rate since 2011, partly due to pressure from a slowdown in food price deflation.
Tesco’s improving supplier relationships are another key strength. Improved sales have brought about a “virtuous circle” says Lewis: better deals with suppliers, driving more price cuts and further volume growth - and consequently even better deals with suppliers. Additionally, despite ‘Marmite-gate’, overall, it appears Tesco does recognise some suppliers face legitimate cost pressures, particularly from sterling’s devaluation. Under such circumstances, it has made it clear that it will try to offset them by, for example, changing recipes or finding cost savings. Tesco’s goal is to earn between 3.5 pence and 4 pence of operating profit for every 1 pound spent by shoppers, up from 2.18 pence currently. That achievement, despite the reduction of some 10 million square feet of store space since 2014, would make a return to a 30% UK market share from 28.2% not particularly punchy call, and an interesting trade call for 2017.
More Blockbuster IPOs
A rise in IPO volumes in the third quarter of the year, after a big slowdown overall in 2016 points to a big rebound in share listings in the New Year, with icing on top. Not that 2016 was exactly quiet for IPOs. But at, US$79.4bn, January-September global IPO proceeds were 39% lower than in the same period in 2015 and deal volumes (704) were down by 23%, says Ernst & Young. Quarter-over-quarter in Q3 the rise was 16% compared to 2Q16 to US$35.4bn, and also strong compared with 3Q15—up 84% with the number of deals rising by 21%.
The outlook for 2017 is better, given improving economic fundamentals, chiefly in the U.S. While a return to the record levels of activity in 2014 may be a stretch, the IPO activity for 2017 is expected to surpass 2016, and could even beat proceeds in both due to the return of the kind of blockbuster IPOs that 2016 lacked. Whilst investors will now have to wait another year for the biggest IPO of all time (Aramco) we believe Snap Interactive Inc. (Snapchat) is planning to launch on the stock market in the first or second quarter of 2017.
With a current valuation of $18bn, timed right, the group could match the last big tech IPO, in 2014, when Alibaba (NYSE:BABA) raised $22bn. 2018 is sorted too: Aramco’s IPO just keeps growing. Saudi’s oil production vehicle now plans to include all of its businesses in the float, having initially outlined plans to sell just downstream operations.
And whilst officially, the Kingdom has indicated an approximate 5% stake would be floated, it has not ruled out expanding the size of the portion given the wider number of assets, and demand. From initial market soundings of around $1 trillion, Saudi has not sought to downplay more recent consensus for a float of at least $2 trillion.
Even that would be a fraction of the worth of the group, which has 12 times the reserve of ExxonMobil (NYSE:XOM). Advisers to the Saudi oil ministry estimate its total value at $10 trillion. Of course, if our previous prediction comes true and the oil price falls to $15 per barrel, then we could see the Aramco float delayed for another year.
by Kathleen Brooks and City Index's Research and Risk Team
Ellen R. Wald, Ph.D.: Oil Price Will Stabilize; Shale Producers, Energy Investments To Revive
The price of oil should finally stabilize in 2017. OPEC, coming off its productive meeting at the end of November, is once again saying the right things and working towards cooperation to limit production and raise prices. The OPEC production cuts may never be implemented fully and likely will not last for too long, and further hurdles remain to bringing the full range of non-OPEC producers on board, but the movement is now clearly in the direction of combined production limits.
The impact on Tehran of the soon to be inaugurated Trump administration should also be favorable for oil prices, with the possibility of renewed sanctions and the certainty of added unease for foreign firms considering investments in Iran. The messages coming out of OPEC and Russia alone, will create price spikes, while the actions should set a floor price of at least $55.
The Aramco IPO—coming either in late 2017 or in 2018—will be a success. Aramco is too well run and controls resources that are far too valuable for it to not succeed. However, investors will need to understand that the company will still be run by the Saudis and investors will only be along for the ride.
In the U.S., higher oil prices will bring renewed life to some shale producers. Changes in government policy, brought by a new and friendly Republican administration, will open opportunities for a myriad of energy-related investments and businesses. Drilling on Federal land and offshore, especially along the Southeastern coastline, will be easier for small and large producers alike. Energy infrastructure projects, including pipelines, will see renewed possibilities as well. However, railroads as a transportation for oil will suffer if pipelines become preferred once again.
As was the case last year, a safe prediction is that:
“with continued low crude oil prices [below the 2014 highs of $112bbl], decreased global passion for climate change, and… a Republican administration in the White House, investors should be wary of renewable and clean technology in the long term.”
Even when oil prices stabilize, it will be a while before they reach the high double digits that precipitated such economic interest in alternative energies.
Moreover, the global mood is turning against climate change fear. President-elect Trump has stated multiple times that he supports “all” forms of energy, but investors should expect that any changes in the U.S. tax code will hurt alternative energy and electric car startups. The Department of Energy will likely alter or lessen its venture-capital-like behavior as well, providing less Federal assistance to alternative energy businesses.
For more risky opportunities, consider refining projects in both India and the U.S. While India is not likely to become the next China for energy consumption purposes, India is now the third largest energy consumer and will be particularly in need of enhanced refining capacity.
American refineries are also in need of an upgrade, particularly to handle the volume and type of shale oil produced. Before the U.S. is able to increase its refining capacity, however, look for U.S. oil exports to pick up in 2017.
Matthew Ashley: GBP, EUR, AUD Likely Under Fire In 2017
In the coming year, the markets are likely to be dominated by geopolitical forces and stifled GDP growth which will have a myriad of consequences. Among the currencies likely to be most exposed to these forces will be the GBP, EUR, and AUD. As a result, the bears out there could be cruising for a year of sizable downside potential.
Starting with the GBP, the inescapable fallout of Brexit will still be felt next year, especially as the UK government navigates its disentanglement from the Eurozone. As a result of this, the policy responses from the Teresa May-led government will be in the headlights and news regarding the negotiations around Brexit and the role of the UK going forward could be as influential as Interest rates or even GDP results. Moreover, given the current lean towards a “Hard Brexit” the outlook is looking fairly grim for the UK and, by extension, the GBP. The cost of a hard Brexit is forecasted at around £66bn per annum for the UK Treasury and could reduce long-term GDP growth in the UK by up to 9.5%.
Looking across the channel, the EUR could be in for a no easier time than its UK counterpart. Whilst the effects of Brexit will be somewhat more muted on the continent, the EU faces challenges from within which could keep the EUR depressed in the coming year. Specifically, the growing fears over the rise of Front National, in the wake of the apparent global swing towards hard-right populist leadership, will be central to the EUR’s health moving forward. This is due to Ms. Le Pen’s commitment to following the UK’s lead and exiting France from the EU, the result of which would likely be catastrophic for the Union. Consequently, assuming we have learned our lesson from both the Brexit and Donald Trump, the market should be giving the EUR a wide birth as long as Ms. Le Pen has a shot at seizing power.
Finally, the antipodes will also be feeling the heat as the threat of recession looms over the Australian economy. Only recently having posted a contractionary quarterly GDP result of -0.5%, speculation is already rife that the nation’s mining boom is no longer able to prop up the economy. Such fears are hardly surprising, especially given dwindling CAPEX and investment over the last 12 consecutive quarters. As a result of the impending downturn, expectations of stimulative interest rate cuts in the New Year will be surging which will likely put the Aussie dollar under some significant pressure. What’s more, the effect of these cuts will spill over to the country’s Pacific neighbour, New Zealand, and force them to follow suit and devalue the NZD in the process.
Anna Coulling: Surging Dollar, Oil To Test $62, Euro Project Uncertainty, Gold Could Shine Again
There is a Benjamin Graham quote that is often misquoted in which he was supposed to have declared that in the short term the market is a 'voting machine', but long term it is a 'weighing machine'. But what he actually wrote in 1934 in his book Security Analysis was this:
'..the market is not a weighing machine....Rather we should say the market is a voting machine, whereon countless individuals register choices which are partly the product of reason and partly the product of emotion....Hence the prices of common stocks are not carefully thought out computations, but the resultant of a welter of human reactions......'
That's a particularly apposite quote in the aftermath of the US Presidential election, as traders and investors now face major shifts in both monetary and fiscal policy, not only in the US but in all the major economies. And our mantra for 2017 should be 'expect the unexpected', something many financial experts, commentators and pollsters singularly failed to do in 2016!
Thus far it has been US equity markets that have continued to defy commentators and analysts with November's volatility simply viewed as an opportunity to push the benchmark indices into new high ground. Indeed the lack of any meaningful correction in equity markets has been the concern of many in 2016, particularly when the average number of days before a 20% correction is usually 635 days. The present market is overdue by more than three times this average. But the key here is not whether the indices will continue this record breaking run, but which sectors are likely to flourish in the new monetary and fiscal environment. President elect Trump has already outlined some of his priorities, namely major infrastructure spending, which has already resulted in stocks such as Caterpillar (NYSE:CAT) moving sharply higher. Other sectors to watch will be health care and pharmaceuticals, particularly if there is a major restructuring or abandonment of Obamacare.
Underpinning this shift will be a normalization of interest rates, and a consequent rise in inflation, two factors that have always favoured the financial sector and gold.
For the US dollar the Trump win was the catalyst for the breakaway from the long consolidation phase on the DXY, with the break of the March 2015 high of 101.38 taking the index to 102.12 in the days following the election. From a technical perspective the upside levels to watch on the DXY are 102.82 of August 1998 and 106.52 of June 1989. Any break through these levels would clear the way for a re-test of the 2001 and 2002 highs of 121.29 and 120.80 respectively. The prospect of a surge in the USD in 2017 has many implications, not least for emerging markets where the prospect of having to service more than 3 trillion in dollar-denominated debt has the potential to destabilize the entire global economy.
The impact of a surging dollar in the currency markets, in particular against the euro, will also coincide with the single currency once again facing further threats to its very existence as well as the prospect of moving to parity, and lower still. If we start with the technical picture, the key price region for 2017 is 1.0450 to 1.0500, an area that was tested on several occasions in 2016, but has so far held firm, and has been providing a strong platform of support since 2015. However,if a move to parity is almost certain, with the potential to move down to the 0.9450, a price region last seen in mid 2002.
From a fundamental and political perspective the pressures on the euro are many and varied. First, we have the ongoing bailout drama in Greece which has continued to fester in the background, but still has the potential to erupt at any time causing the single currency—and the markets—further volatility and uncertainty.
To this we must now add the situation in Italy where a banking crisis in which bad loans at Italy's third largest lender, Monte dei Paschi di Siena (MI:BMPS), a bank founded in the 15th century, is threatening to spill over and contaminate the wider European banking system. In addition the political landscape in Italy is far from stable following November's referendum, and any failure to establish a new Government will inevitably lead to fresh elections in which eurosceptic parties are projected to gain a significant share of the votes.
These parties have made no secret of the fact that, if granted the opportunity, they will call for a referendum on Italy's continuing participation in the euro project. However, this will not be a replay of Brexit, as most Italians are still in favour of the eurozone.
If Italy does manage to avoid an election, elections in Holland, France and Germany in March, May and October respectively, all have the potential to cause the euro, and eurozone further angst, and even call into question its very existence. The Dutch election will be interesting as it will be the first opportunity to gauge the extent to which eurosceptic rhetoric translates into votes and power. However, it is the French election in May which is potentially the most explosive given France's role as a founder member of the what was originally known as the Common Market.
For France, next year will be a test of whether Marine Le Pen's National Front (FN) party can take power and offer the French a referendum on membership of the EU. However, unlike the UK France has a written constitution that binds it to the European Union and which theoretically precludes it from any easy exit. The key here will be the level of support for the National Front, and whether this will be sufficient to instigate any constitutional changes to offer the French electorate this choice. And unlike previous euro crisis, this would indeed herald the demise of the euro project in its current iteration. In short, 2017 could be the year that decides Europe's and the euro's fate.
For oil, 2017 will be another cocktail of politics, posturing and play acting. On the one hand we have OPEC balancing the demands of its member states, controlling supply from non members whilst simultaneously involved in a price war with the alternative suppliers. This is a novel experience for OPEC who are now the 'jam in the sandwich' and under pressure from all sides. Tighten supply too much, and prices are likely to rise further, thereby encouraging the alternative suppliers.
A loosening of supply will see prices fall, but increase pressure from members and non member alike with the prospect of tentative agreements now in place with Russia and other producers fracturing. From a technical perspective the recent agreements have seen oil prices spike higher, and up to test the highs of 2016 in the $55.50 per barrel price region.
This is now a key level of potential resistance, and with volumes now building on both the weekly and monthly charts and with a sustained congestion phase now underpinning the price action we could see oil prices continue higher to test the $62 per barrel area early in 2017. Longer term we may even see a return to the $72.00 per barrel region of 2015.
And finally to gold, which in the light of increasing interest rates, inflation, banking crisis and existential threat to the euro may finally shine once again. However, from a technical perspective the precious metal still looks bearish on the monthly chart. The key levels now in play are those at $1120 per ounce, and if this is taken out potential support awaits at $1050 per ounce.
If this is breached, then a move below $1000 per ounce looks increasingly likely. To the upside, strong resistance has been building over the past two years in the $1360 region. With volumes rising in a falling market on the monthly time frame this level looks unlikely to be tested.
In summary, whilst 2017 promises to deliver fresh levels uncertainty and volatility it will also offer plenty of trading opportunities—provided we understand the continuing interplay between politics and economics.