OPINION | The unfolding impacts of recent and upcoming geopolitical events are set to affect monetary and fiscal policy, economic growth and inflation, as well as investor sentiment and, in turn, asset prices in 2017.
Surprises for markets abounded in the geopolitical sphere in 2016. The United Kingdom’s Brexit vote and Donald Trump’s win in the United States presidential election were standout events.
Markets demonstrated their anticipatory characteristics in spades, moving ahead of actual developments and economic data; and economic divergence among major economies became increasingly evident.
The result was periods of heightened volatility in response to surprises. Think no further than the fast twitch from doom to upbeat optimism following Trump’s victory, or the price gyrations of Australian real-estate investment trusts in response to changes in investor appetite for yield.
A strong end to 2016 brought some optimism into the new year, but the uncertainty and market volatility of the past 12 months will probably continue.
Flexible strategy is essential
Potential geopolitical triggers are not in short supply. There’s the inauguration of President Trump and his early policy initiatives, particularly on trade and China; next steps in Brexit; elections in France, Germany, Italy and the Netherlands; and oil producers needing to live up to the global deal to cut supply.
For longer term investors such as Sunsuper, it’s important to assess the probable medium- to longer-term impacts of these events and the expectations for asset prices, while having the flexibility in strategy to deal with inevitable variations.
Short-term volatility around geopolitical events may provide us with opportunities to manage risk or enhance returns, as it did in 2016, but it is the longer horizon that is most important.
Modest expectations
Economic growth has been lacklustre on a global basis, having slowed progressively since 2010. The prospect of fiscal stimulus and other company-friendly policies under Trump have been seen by many to signal a stronger US economy and higher inflation. But it remains to be seen how this will play out. We may get stagflation.
The German economy is also showing signs of sustained strength. However, other areas of Europe continue to grow at sub-par levels, Japan has failed to maintain its economic momentum after the initial outcomes of President Shinzō Abe’s reforms, and emerging market economies are perceived to be losers from Trump’s potential trade policies and a higher US dollar.
What this all means for equity and bond markets is far from clear.
Equities are reasonably fully priced, even if corporate profits do improve in response to better economic conditions. If anything, equities may be a little exposed to disappointment if some of the Trump policies and other stimulative measures (including a Federal Reserve reluctant to step on the brakes too swiftly through interest-rate rises) fail to meet expectations.
How Brexit plays out is another complication and global trade may retreat further due to resulting protectionist policies. Domestically, the Australian equity market will probably take its lead from broader global growth expectations, particularly among major trading partners.
Expectations of higher inflation and the normalisation of short-term interest rates in the US were rapidly reflected in bond prices in the latter stages of 2016, most clearly in US Treasuries. Inflation is unlikely to surprise to the upside of expectations in the next two years or so, due to underused capacity in many economies.
There is an increasing recognition that accommodative monetary policy with low or negative interest rates is harsh for savers and holds back lending. This is prompting expectations – and isolated action in the case of Japan and Canada – of higher levels of government spending.
Time will tell
To the extent this spending flows to investment in infrastructure and other long-term projects – where it could generate longer-term benefits for economic growth – equities in general and certain sectors in particular could gain increased earnings and prices.
However, these effects emerge over time. Their near-term impact on markets is less certain, especially relative to the quarterly news cycle of monetary policy. These transitions may be accompanied by volatility, too, as investors weigh up the extent to which higher deficits to support government spending and less accommodative monetary policy will drive up interest rates. This has implications for everything from US Treasuries to higher yielding assets, like property.
Property investments in Australian institutional portfolios are largely domestic. With measured growth in supply (new construction) in most capital cities, ongoing demand from offshore buyers and prospects for sound economic activity, the outlook for both prices and incomes looks solid. This is particularly true of the Sydney and Melbourne markets, reflecting the relative economic performance of the states over recent times.
There are prospects of some upside to economic activity in 2017, but much of that has already been priced into markets and further positive surprises seem unlikely.
Returns for diversified portfolios will probably be moderate in 2017 and could even disappoint if much of the promise carried forward from 2016 fails to materialise. Uncertainty hasn’t dissipated though. Expect some volatility throughout the year.
Ian Patrick is the chief investment officer of Brisbane-based industry superannuation fund Sunsuper, managing more than $38 billion in funds on behalf of 1 million members.
