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Market Comment - December 2016

Market Comment

We ended the year on a surprisingly strong note given the political upsets in the US and the UK, the rising geopolitical risk and the Fed embarking on a trajectory of tighter monetary policy. While markets were dominated throughout the year by monetary policy, in December the focus was on the incoming US administration and the potential effect of new economic policies. Despite the apparent fear projected in the media we witnessed surprising strength in equities as investors considered potential fiscal stimulus, infrastructure and job creation programs while ignoring the expected potentially inflammatory foreign policy approach of the new president. This also overcame the Fed’s rate rise during the month for the first time in over a year. The European Central Bank stated in December that it would be increasing the duration of its quantitative easing programme until December 2017 while reducing its bond purchases from €80Bn a month to €60Bn a month.  

During the month the S&P was up 1.82% resulting in an impressive 9.54% return for the year. Treasury yields were higher across the board as they priced in higher inflation and tighter monetary policy. Energy markets were higher, mainly driven by an Opec agreement on production cuts during the month.

In 2017, investors are likely to focus more on geopolitical issues and economic policy. This will be a significant shift from recent years of trading on central bank activity globally. It is not clear what the new Trump administration will implement but judging by the election promises and subsequent rhetoric investors can expect some significant changes. The market’s very positive reaction to promises of tax cuts, infrastructure spending and reduction in regulation may fade as the reality of politics takes hold. When combined with a complete reset of diplomatic relations with other countries especially China and the European Union, we can expect increased volatility during the year. The approach to the Middle East and a pivot towards Russia will also provide markets with much to consider.

In Europe we face elections in France and Germany. The EU is faced with significant challenges and rising hostility in many countries to membership of the Union. Slow growth, high unemployment, and immigrant crises are contributing to the rise of nationalist political parties. France will be the main focus with elections early in the year. The right wing nationalist party of Marine Le Pen has risen significantly in recent times and although not the favourite, there is a real chance that it could succeed. This could trigger an exit of France from the EU and probably presage a break-up of the single currency.

Greece will be facing talks with its international creditors, with the IMF pushing for a debt restructuring. Greece cannot continue under the current terms and a further bailout will only heap more debt on the existing unsustainable levels. The choice may boil down to a debt restructuring or exit from the EU although Germany may look to force some kind of compromise to yet again avoid the inevitable.

Even if the aggressive economic stimulus from the US is enacted, the global picture of slow growth and political risk is likely to curtail rises in US bond yields.