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Market Comment - January 2017

Market Comment

Investors’ desire for risk continued into the New Year with most major equity markets finishing in positive territory. US Treasury yields and corporate credit spreads did not move much but high yield bond markets continued to grind higher. This renewed risk appetite is being driven by a number of factors.

Firstly, there appears to be some momentum in the global economy and that is increasing the appetite for cyclical stocks. The low rate environment continues to depress investment returns elsewhere and is forcing investors into equities. The combination of strong markets, improving economic data and cheap debt has created a strong backdrop for M&A transactions. Investors in the US are also very encouraged by the new administration’s stated desire to employ fiscal stimulus measures such as tax cuts and infrastructure spending programs.

The level of optimism is surprising given that markets are pricing a very rosy scenario for US and global growth while a significant amount of execution risk exists for the policy makers. In Europe there are a number of catalysts such as the French and Dutch elections that could send the Eurozone into crisis or at least significantly undermine sentiment. Furthermore Greece may be coming close to a debt restructuring or exit from the Euro while in the UK, the Brexit process gets underway.

The most significant market event is likely to be the extent of changes to US interest rates. It appears that a March rise is already priced in. However, the Fed has indicated further rises later in the year. Investors seem quite sanguine about a scenario of increasing rates that has traditionally led to a significant repricing of risk assets or even a crisis in recent decades. Markets appear to be expecting stable longer term rates. This is a function of the need to keep the recovery on track and the external forces of low long term rates in Europe and Japan.