World Economic Outlook 2017 by top industry players
Brexit was seen as a Lehman-type risk for the markets. Trump’s election a few months later was perceived as an even bigger negative. And yet the stock market continues to grind higher. All of this makes the outlook for 2017 unusually interesting, but also difficult to call. It remains to be seen, for example, whether or not the so-called “Trump rally” is sustainable. In this article we take a look at the outlook for economies and financial markets, as outlined by some of the big name US and European financial institutions.
Goldman Sachs highlights four transitions that will occur this year
First of all, we take a look at Goldman Sachs’ outlook for the year. GS predicts that 2017 will be a year of transition. It highlights four key changes that are currently underway. We outline these below.
1. Globalism to Populism. The key to how this transition plays out is naturally what happens under the Trump administration over the next 12 months. The finer details of Trump’s economic policies and priorities will become clearer within 100 days. Meanwhile, election campaigns in Europe show the extent to which populism is a rising force on a global basis. Goldman says it is increasingly easy to be skeptical about the Euro's prospects for survival. If investment in Europe tails off or is postponed, this will naturally have an adverse effect on the region’s potential for revival and growth this year.
The United States is now moving towards a more protectionist approach in its trade policies. In terms of the economic impact this may have, the reaction of countries like China will be key.
2. Stagnation to Inflation. With inflation starting to rise once more, inflation expectations become more important than the actual rate of inflation. Although inflation is generally positive for stock prices, rising input costs will inevitably lead to lower corporate profits. On the other hand, inflation is negative for government bonds and is likely to increase volatility in credit markets. Interest rates will continue to rise. This will have a negative impact on sectors such as utilities and consumer goods.
3. Monetary to Fiscal Policy. Quantitative easing by the ECB (European Central Bank) and the Bank of Japan may slow, and this in turn will lead increased volatility in bond markets and a more “risk-off” mindset on the part of investors. Trump’s appointees for vacant seats on the Federal Reserve Board of Governors will naturally be key in determining the direction of future monetary policy. Goldman anticipates that Fed rate hikes will happen faster than the market expects. This need not be an issue as long as inflation continues to be seen as positive for corporate earnings and a support for stock prices.
4. Regulation to De-Regulation. It remains to be seen whether movements towards financial deregulation in the US affect financial regulatory trends in the UK and Europe. Deregulation in the US is likely to push up lending and to offset the tightening impact of rising interest rates and a stronger dollar. Energy and Healthcare are two sectors likely to see increased profit opportunities as a result of deregulation.
In Europe, Brexit is expected to lead to an increase in administrative costs, for example, laws and regulations. This in turn will act as a constraint on corporate earnings. China will place increased emphasis on economic stability, rather than reform, ahead of the party convention in autumn this year. This means that the threat of disruption to the global macro from China is less of an issue than the market currently believes.
In Goldman’s view, global growth in 2017 will be broadly flat at 3.2%. The US will accelerate from 1.6% to 2.1%, while the euro zone will decelerate from 1.6% to 0.8%. In emerging markets, GS sees growth slowing in China and India. However, it also expects Brazil and Russia to move from negative growth to positive growth.
In terms of the US stock market, Goldman sees the key theme driving the market in first half of the year as "Hope". But it expects this will quickly move to “Fear” in the second half. Goldman sees the S&P 500 moving towards 2400, but falling back to 2300 as “Fear” takes hold in H2. It sees the TOPIX at 1600 at end-2017.
Goldman expects US rates to rise by 0.75% in 2017. Trump’s economic policies will naturally encourage rates to rise, in turn leading to further strengthening in the dollar. A continued dollar rally will be a negative for emerging markets.
Blackrock looks to Japan and EM
Next, we take a look at the 2017 outlook from Blackrock, the world’s largest asset manager. The key point Blackrock emphasizes is that we are now approaching the end of global deflation. In the United States, inflation is rising as the labor market tightens, whereas, in other developed countries, inflation is broadly flat.
We are now at a major turning point in terms of the financial markets. The slowdown in the growth of the world economy bottomed last year, and it looks as if growth will now start to improve. The Trump administration’s fiscal policy will accelerate growth, but, so far, it is unclear to what extent. Stock prices are expected to rise.
Interest rates have bottomed out, and as reflation occurs, stocks are more attractive than bonds. The financial system’s ability to take on risk has been curbed by regulation post-2009. Measures of risk appetite remain subdued, compared with previous cycles, which means that, in Blackrock’s opinion, stock prices still have further to rise. Interest rates will continue to move up, so Blackrock recommends being underweight sectors such as Utilities, and being overweight Finance.
Long-held relationships across asset classes appear to be breaking down. Past correlations such as the negative relationship between stocks and bonds no longer apply. This means traditional methods of portfolio diversification, based on historical correlations and returns to derive an optimum asset mix, may be less effective.
Emerging economies in 2017 will provide opportunities for higher returns. Reflation is potentially a supporting factor for the bond market in emerging countries. Taking account of the potential effects of trade friction, as well as volatile investor sentiment, Blackrock argues that emerging markets offer an attractive opportunity to boost portfolio returns.
The depreciation of the yen will improve Japanese corporate earnings in 2017. The Bank of Japan's zero long-term interest rate target is also a supporting factor.
Populism in Europe is increasing, so investors need to remain vigilant for political risk. Also, there remain risks related to capital outflows from China and yuan depreciation. Blackrock does not think there will be a severe devaluation of the yuan, although gradual depreciation of the currency will continue. Indicators of potential capital outflows from China need to be watched carefully.
Morgan Stanley: Bullish on the US, cautious on Europe
We now look at the outlook from Morgan Stanley (MS), another of the major US banks.
Morgan Stanley’s outlook for the global and the US economy does not differ markedly from Goldman’s or Blackrock’s. However, it is more cautious on its interest rate view, believing that a strong dollar will act as a constraint on inflation. It forecasts the 10-year bond yield at the end of 2017 at 2.5%. Dollar strength, rising inflation, and a more protectionist bias in trade policy will curb US growth prospects. Morgan Stanley forecasts a modest 2.0% for 2017 US GDP. On the other hand, it expects inflation to move up to 2.4%, higher than most other forecasters.
Dollar strength has more of an impact on investment in emerging markets, but Morgan Stanley recommends Brazil, Argentina and Russia as markets seeing the benefits of economic improvement and easing monetary policy.
It sees the S&P 500 at 2300 at end-2017, with the TOPIX at 1800. It expects the dollar to strengthen and the yen to weaken. It sees USD/Yen at 125 yen.
Citibank, Bank of America, JP Morgan Chase
Next, we look at what three of the other US banking majors have to say.
Citibank's end-2017 S&P target is 2325. It sees 1625 for the TOPIX. It believes the US economy is not yet strong enough for the Fed to raise interest rates drastically, so it sees a limit to the dollar's ability to rise. It expects rising inflation to boost the gold price, and sets a gold price forecast range of $1,225-1,325 per ounce.
Bank of America forecasts 2300 for the S&P 500. Its forecast for the average price of crude oil (WTI) in 2017 is $59 per barrel, a slight upgrade on its previous estimate. It is more cautious on the gold price, expecting $1,250 per ounce by mid-year. It expects US consumer spending (core PCE price index) to remain subdued, up 1.9% by the end of 2017.
JP Morgan Chase (JPM) is the most bullish of the commentators on US economic prospects, and has a 2400 target for the S&P by the end of 2017. It highlights the risk that US corporate profitability is adversely impacted by dollar strength. Europe is expected to grow steadily, but at a low rate. Japan is recommended because of the support offered by loose monetary policy. JPM Chase says that the conditions are right for monetary easing in emerging markets, with the risks of rapid currency depreciation and inflation overdone. EM stock markets are expected to outperform developed countries.
How European banks see the outlook
Finally, we look at what the major European banks are saying.
Credit Suisse's 2017 targets are 2230 for the S&P and 1430 for the TOPIX, lower than most other commentators. It also similarly cautious on the 10 year US Treasury yield at 2.4%. CS’s view is that rising interest rates and labor costs will lead to US corporate earnings missing expectations.
Deutsche Bank expects the S&P 500 to be 2350 at the end of the year. It sees US rates rising, but expects the yield on 10-year Treasury bonds to be only 2.3%, again quite a modest forecast. It points out that stagnating trade will hold back global growth in general, but also highlights the impact of political risk in Europe.
Summarizing the outlook: the risks are clear
In summary, the majority of commentators are pointing out the global shift from disinflation back to inflation, and suggesting that the decline in global growth has bottomed out. There are varying levels of agreement, but the consensus expectation is that the dollar continues to strengthen, and that rates are on an upward trend, as is inflation. Stock prices should remain well underpinned against this backdrop. Meanwhile, side by side with risks of global protectionism, are political risk in Europe, and a potential economic “hard landing” in China.
Growing inflation may lead to a more “risk on” approach by investors, but there is still agreement on the view that emerging markets will outperform developed markets this year. A number of commentators also recommend Japan, with the weak yen generally a positive for the stock market.
Finally, in terms of Trump, many forecasters suggest that sentiment is overdone in both directions (either positive expectations, or else concerns, over the effect of his policies). In their view, Trump’s pledges on fiscal policy will be toned down, and his immigration and trade policies will ultimately not be as radical as his rhetoric has suggested. On balance, the Trump effect on the economy and on financial markets is likely to be positive.