2017 Outlook: Focus Shifts to Fiscal Policy & Populist Politics

Neil Dwane | 01/12/2016
2017 Outlook

Summary

As the markets close the books on another tumultuous year, investors should keep watch on the rise of populist politics, China’s re-emergence as a global growth engine and a renewed focus on government spending as interest rates remain low.


Key takeaways
  • Populist politics will drive market volatility: Europe will confront a year of Brexit-fuelled political uncertainty within a slow, low and dull global economic environment. As US policy turns inward, we expect China and Russia to get more assertive.

  • Lower-for-longer rates will linger: Financial repression will remain in effect as the world finds new ways to delever. Inflation will remain key, but it takes decades to work. Facing volatility and low beta returns, investors must be active and seek alpha.

  • Hopes will turn from monetary to fiscal policy: Negative interest rate policies and quantitative easing will evolve as countries shift attention from monetary to fiscal policy – though new fiscal efforts may not be big enough nor economically effective.

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This past year has been an exhausting one for many investors: China started rebalancing, the Fed failed to raise rates, Europe grappled with Brexit, tensions rose in Ukraine and the Middle East, and the US suffered through painful elections before ultimately choosing Donald Trump. Surprisingly, while any one of these events could have caused a serious market setback, they kept plugging along valiantly – albeit with bouts of volatility – even as global growth stayed slow.

For their part, central banks all but exhausted themselves this year with their extreme monetary policies, prompting a renewed focus on fiscal expansion as one of the few remaining ways governments can hope to stimulate much-needed growth.

Moreover, economies around the world are still grappling with monumental levels of excess debt that are only serviceable at record-low interest-rate levels. As such, we expect 2017 to be a year of nominal growth and low returns as our long-running thesis of financial repression remains in full effect.



2017 outlook by region

  • US: Escape velocity elusive as Fed tries to raise rates – yet consumers see little wage growth, and health-care costs start to rise. Trump boosts infrastructure and defence spending, pushes for return of cash held overseas. US dollar could weaken.
  • Europe: Investors grow nervous about cloudy outlook from elections and triggering of Article 50. Euro-zone financials weaken, hurt by ECB’s moves toward tapering. Equities look attractive and high- yielding in a marketplace distorted by QE and NIRP. Growth should slow.
  • Asia and EM: Fundamental economic restructuring in China, India and Indonesia offset stronger USD and slower global trade momentum. Rising global protectionism boosts regional development, spurring local consumer spending. Commodity outlook changes with China’s shift to oil and softs.
  • Japan: Economic growth still very fragile as demographics and policy uncertainty affect confidence. New fiscal dominance allows Abe (with BOJ support) to legislate for inflation, which boosts domestic activity at yen’s expense.

5 investment themes to understand in 2017

As the markets close the books on one year and turn their attention to the next, investors looking to make informed decisions need to understand what’s driving markets and economies. Here are the core themes to watch in the coming year.

Global economic growth: Still low, slow and dull
Investors should expect muted growth as the US enters its late-cycle period, Japan struggles with its ageing population and Europe suffers from Brexitosis. The US and EU should ultimately avoid recessions while staying stuck in the weakest economic expansions ever recorded. Emerging markets should prosper as China rebalances and much of Asia reforms.

Central banks: Rates "lower for longer” overall
We expect the US Federal Reserve to modestly increase rates, prompting central banks in emerging markets to lower their rates as inflation falls. The European Central Bank and Bank of Japan should maintain their loose monetary policies. We have passed peak global liquidity as central banks have pushed past negative interest-rate policies to begin supporting government spending.

China is still the big story, with Asia attractive overall
The biggest contributor to global growth is still China, which is requiring fewer industrial commodities and more oil and soft commodities as it urbanizes rapidly. Concerns remain over its capital position, but its "one belt, one road" policy for expanding trade and investment may be the new Marshall Plan the world needs after the Global Financial Crisis. With India and Indonesia now making significant reform progress, Asia offers the best balance of growth and investment.

Oil sees demand and supply fall into balance
For some time, we have advised investors not to expect oil prices to stay too low for too long, and our constructive position has begun to be validated. These very same low oil prices have led to receding industrial capital expenditures, and have helped demand and supply fall into balance. We believe a slightly rising oil price in 2017 should boost oil investment and global inflation, but we believe it will not ignite a new shale boom in the US. Supply will still be pressured by a fraught geopolitical situation in the Middle East, Latin America and Africa.

A change in political trends is underway
The tides of de-regulation continued shifting in 2016, and nationalism and populism gained ground: Brexit, the Walloons, Bernie Sanders and Donald Trump all played a part. Given the significant elections looming in Europe in 2017, politics should remain a key investment consideration – though some investors may simply stay away from certain markets despite attractive valuations. Monetary policy will also become more political as it becomes subsumed by explicit government policies of fiscal domination. As to where governments will spend the money their central banks print, we believe domestic infrastructure and defence spending will be the focus of many countries in the coming years.



Asia is investing in long-term competitiveness through increased R&D

Research and development as a percentage of GDP is highest in Korea and Japan

Chart

Source: OECD, Allianz Global Investors, data as at December 2013. *US, Canada and Israel data are as at December 2012. Size of the circle reflects the relative amount of annual R&D spending by the indicated country.



Taking action with a renewed focus on active investing

In many ways, 2017 will offer the same diet as 2016: Thanks to low market returns, investors who take insufficient risk will generally find insufficient results. Moreover, the historical long-term performance many investors hope to see again looks to be just that – a thing of the past. The future demands active, incisive hunting for capital-growth and income opportunities as we wait for a turn in the economic cycle to come one year closer.

Reaching objectives means taking risk
The broad market returns (beta) of many asset classes could feasibly go even lower: Without the earnings growth the markets have been waiting for, yields cannot fall further and equities cannot rerate higher. Taking some credit and duration risk – and employing dividend-focused strategies – may help protect the purchasing power of savings against inflation’s ability to slowly increase health-care, education and living expenses.

Become more selective and active
As beta becomes more volatile, investors need to assess their desire for capital growth (through real assets like growth-style equities and property) against their need for income (which can found in fixed-income and short-duration assets in Asia, the US and emerging markets). Investors can then use active strategies appropriately to generate above-market returns (alpha). Significant diversification with alternative investments can help.

Investing requires patience
As the markets increasingly focus on the short term, investors ironically must become more patient and contrarian: The power of compounding takes time to work in growth- and income-focused strategies, so a long-term perspective is essential for optimizing results.

Diversify, don’t herd
Asset correlations and volatility are high, which could cause different asset classes to swing wildly in the same direction. Extreme monetary policy measures from central banks – such as negative interest-rate policies and quantitative easing – have also herded many investors into the same positions, which may reduce returns. Look for strategies that offer risk-mitigation and diversification potential – like alternatives.

Volatility is unavoidable, but manageable
Markets are increasingly susceptible to volatility as politics, geopolitics, divergent monetary policies and internal market structures all converge and evolve. Navigating this sea of uncertainty requires a clear direction and an ACTive mindset, with investors staying agile in their asset allocations, confident in their processes and thorough in their research.



Metrics to watch

Inflation

Fears over deflation and disinflation could fall as inflation rises

  • As monetary policy shifts toward supporting fiscal policy, it could create rising real-world prices.
  • China's rebalancing – plus lower commodity prices and collapsing investment – will tighten supply chains, leaving pricing power in stronger hands.
  • Fiscal dominance will allow governments to create inflation via legislation through higher minimum wages and other inflationary policies.

0.2% Eurosytem inflation Q4 2016

1.2% Eurosystem inflation + one year

Source: ECB as at 18 Nov 2016. Inflation defined as year-onyear percentage change of the Harmonised Index of Consumer Prices published by Eurostat.

Volatility

Volatility could spike from passive’s rise and regulatory shifts

  • The move toward passive investing globally has concentrated flows into certain market segments, which could become more volatile if flows begin to reverse.
  • Regulatory changes have made the markets more shallow; markets have also been rendered less stable by the rising tide of high-frequency and algorithm-based trading strategies.

13.29 Volatility Index (VIX) as at Sept 2016

20.90 VIX average 1996–Sept 2016

Source: FactSet as at 30 September 2016.





Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This material is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

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Neil Dwane

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Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.

2 Reasons Why the ECB Should Keep Buying Bonds

Franck Dixmier | 07/12/2016
office discussion

Summary

We expect the ECB to extend its asset-purchase program, buying EUR 80 million in bonds each month, because of concerns about low inflation and political volatility. But Trump could be a wild card in the bank’s plans for continued accommodation.

At its 8 December meeting, the European Central Bank (ECB) will very likely extend its asset purchase programme (APP) by six to nine months. We also expect ECB President Mario Draghi to announce some technical adjustments to improve the supply of eligible bonds, such as revising issuer and issue share limits beyond 50 per cent. This will enable the ECB to access even more bonds and maintain its average monthly purchase rate of EUR 80 million.

The ECB will maintain its accommodative stance for two reasons:

  • First, for the past two to three weeks, ECB communications have consistently focused on disappointing inflation figures – especially core inflation, which, in November, came out at 0.8 per cent year over year. This is both too low and too far from the 2 per cent inflation target set by the ECB to achieve its sole stated mission of price stability.
  • Second, today’s volatile political environment shows no signs of calming down. Despite Austria’s decision not to elect a far-right candidate, Italy’s “no” vote sets the stage for continued instability in the euro zone. Looking ahead, both the Netherlands and France go to the polls in the first half of 2017, with each nation’s self-styled “anti-establishment” candidate currently enjoying high levels of popularity.

As to the supply, it is difficult to anticipate whether the current Trump-inspired rise in yields will be sustainable. Should the US president-elect’s economic policy disappoint the markets, the consequent fall in US yields will have a direct downward pressure on euro-zone yields. Currently, the ECB can only buy bonds with yields above its deposit rate of -0.4 per cent and the bank cannot take the risk of a shrinking pool from which to buy.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

© 2016 Allianz Global Investors. All rights reserved.

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Franck Dixmier

Global Head of Fixed Income, CIO Fixed Income Europe
Franck Dixmier is Global Head of Fixed Income and Chief Investment Officer Fixed Income Europe. Franck is a member of the Global Executive Committee as well as the European Executive Committee at Allianz Global Investors. Franck joined Allianz Group in 1995.
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