This year was full of significant changes around the world, from the Brexit referendum to the midyear turn in interest rates, to the election of Donald Trump for president in the U.S.
“At first blush, you’d think this would call for major changes in our economic and capital market outlook,” David Lafferty, senior vice president and chief market strategist at Natixis Global Asset Management, writes in his Capital Market Notes.
However, most of the trends that Lafferty anticipated have either continued or been confirmed by events in 2016.
“Our broadest views for some time now have been that the global economy was slowly gaining traction, that this would lead to modestly higher corporate earnings and stock prices, and put some upward pressure on interest rates, thus detracting from bond returns,” Lafferty writes.
While most developed economies languished with positive but subpar growth in 2016, Lafferty believes 2017 will provide a bit more upside.
In spite of an improving global economy, Lafferty also expect investors’ patience to be tested in the coming year with an increased potential for major economic and market shocks.
“We have (and believe that investors should have) less confidence in almost every economic and market scenario going into 2017,” Lafferty writes.
Here are four risks or uncertainties that Lafferty will be watching in 2017:
1. The Republican clean sweep in the U.S. Congress has allowed the market to price an extreme level of optimism into a Trump presidency, according to Lafferty.
“Markets have largely failed to discount the very real possibility of significant policy or personnel blunders related to China (tariffs and trade policy), Russia, or fallout from corporations targeted by the soon-to-be president,” he says.
2. A disorderly and destructive Brexit negotiation could drag down both the U.K. and EU beyond what current consensus believes is possible, Lafferty writes.
“It may be overly optimistic to presume the negotiations will proceed rationally and that ‘they’ll work it out,’” he says.
3. Inflation risks are now significantly higher globally than at any time since the global financial crisis, according to Lafferty.
He adds that this could raise the risk of a more aggressive Federal Reserve that is fearful of falling behind the inflation curve and/or an uncontrolled ascent of the U.S. dollar. “Both could impair growth in the world’s largest economy,” Lafferty says. “More broadly, combined with higher growth and fleeing bond investors, interest rates could become untethered in a highly leveraged world – more than offsetting the growth impetus from other factors.”
4. With each passing year, Lafferty says, debt continues to accumulate in China in “nearly every corner of the economy” while policymakers fail to institute significant reforms.
“By controlling both the biggest lenders (banks) and the biggest borrowers (state-owned enterprises), the Chinese can extend and pretend for some time,” Lafferty writes. “They cannot, however, repeal the math of credit boom/bust cycles.”
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