The landscape for investors and financial markets is shifting, according to a new Janus report.
Janus Capital Group released its investment outlook for 2017, Janus Market GPS 2017, on Wednesday.
“Stable energy prices, renewed optimism about the U.S. economy and ongoing innovation suggest that new opportunities lie ahead,” the report states. “Meanwhile, for the first time in years, inflation appears to be rising, while China, once the engine of the global economy, grapples with slower growth.”
In the report, investment professionals at Janus shared insights on five trends that they believe will be key considerations for investors in 2017.
1. China’s Credit Bubble
By 2020, Janus projects China will hold almost 30% of global nonbank and corporate and household debt.
China’s share of global gross domestic product has risen to more than 13%, much of which has been fueled by rapidly expanding private-sector credit.
While Janus says China’s credit bubble is not to be taken lightly, the firm also believes it does not pose an immediate threat. In Janus’ estimate, the economy can be controlled internally for three to five more years.
The core of the issue is China’s ongoing policy conundrum, according to Barrington Pitt Miller, an equity research analyst at Janus.
The country has targeted economic growth of 6.5% to 7% annually for the next five years, while also striving to maintain full employment and reduce leverage.
In Pitt Miller’s view, a reduction of the growth target is highly unlikely because social stability is a major concern for the central government. Less growth would mean fewer employed people and could potentially lead to unrest.
In recent years, growth and employment have been sustained through credit and fiscal stimulus.
“There is a fundamental disconnect between the central government’s GDP ambition and its leverage rhetoric,” Pitt Miller said. “Until the economy transitions sufficiently, China cannot slow leverage and achieve the current GDP target. Those two objectives cannot coexist.”
Wages, which are a key source of inflation in service-based economies, averaged more than 2.5% growth year-over-year in 2016, according to Janus’ report.
“That upward pressure, along with post-election stimulus expectations, caused the [Treasury inflation-protected securities] market to raise its inflation expectations,” the report states.
Inflation expectations, which began changing after June’s Brexit vote, have been significantly amplified in the wake of the U.S. presidential election, Janus reports.
Ashwin Alankar, global head of asset allocation at Janus, notes that markets indicate a Trump presidency will be inflationary despite a stronger dollar. The options markets signal continued U.S. dollar strength.
“We see inflationary forces despite a stronger U.S. dollar,” Alankar says in the report. “Inflation will be ignited by domestic spending. We expect the consumer will start to spend and a little pickup in the velocity of money will put the tremendous supply of money to use.”
Janus believes the fear of future expenses will motivate current spending, leaving the U.S. consumer as the driver of upward price pressures. In addition, an increase in the velocity of the massive U.S. money supply will also translate to inflation.
The global economy could benefit as well as other countries import inflation through a stronger dollar, according to Alankar.
3. Economic Growth
Subpar economic growth has humbled investors for the past several years. While the recovery has been shallow, it has been long. Investors are now searching for clues on whether growth continues or stalls.
To address this question, the Janus Asset Allocation Team used its proprietary options-based model, which aggregates the convictions of a broad array of investors to help determine the greatest causes of concern and opportunities for investment.
“The options market is telling us that the risk to interest rates and bonds is elevated as inflationary pressures rise,” Ashwin Alankar, global head of asset allocation and risk management, states. “At the same time, our model indicates meaningful upside potential for equities.”
Could a post-election fiscal stimulus be a catalyst for equities?
Alankar and Myron Scholes, chief investment strategist at Janus, believe that for economic growth to remain buoyant as the Federal Reserve initiates inflation-fighting rate hikes, there must be a catalyst. That catalyst will likely be fiscal stimulus along with other pro-growth agenda items of the Trump administration, according to the report.
Illustrating this point is the bullish view of the options market toward infrastructure stocks.
Crude oil prices recovered during the first half of 2016 and have since been range-bound between $40 and $60 a barrel, according to Janus’ report. Janus believes prices could go even higher in 2017. While range-bound in the near term, crude could even be pushed higher before 2019 if there’s a shock to the system, such as a sustained OPEC production cut, unplanned supply outage or other “exogenous event.”
“The extended trend of supply outstripping demand has mitigated as of late,” the report states. “The continuation of this trend, along with OPEC’s late 2016 announced production cuts, stand to push the crude market back into balance in 2017.”
Fundamental fixed income global analyst Jason Groom also considers the potential impacts of a Trump presidency on the energy sector, which he also believes could help push the price of crude oil higher.
Since the U.S. is the largest consumer of oil, a pro-growth stimulus package from Trump may boost demand, Groom believes. In addition, the potential for aggressive foreign policy actions from Trump could lead to some supply disruption. That may outweigh the supply impact of any additional opening of federal lands to fracking.
According to Janus, an impending supply/demand imbalance presents opportunities for companies with exposure to higher cost sources of supply.
Noah Barrett, an equity research analyst, adds that “many deepwater projects haven’t been sanctioned, increasing the probability of a meaningful supply gap by the end of the decade.”
5. Innovation in Technology and Health Care
Janus’ portfolio managers and research analysts see innovation as a key differentiator across multiple sectors.
In technology, equity portfolio manager Brad Slingerlend believes the current convergence of connectivity, data collection and computing power will lead to what he calls “the Internet of Intelligent Things.”
According to Slingerland, programs using industry-specific algorithms will be able to teach themselves (i.e., “learn”) as they process data, making it possible to identify relationships and achieve solutions far beyond the scope of human programmers.
The report points out that machine learning’s potential was on display in 2016 when Alphabet reduced power consumption at its data centers by 15% using these types of algorithms.
According to the report, technology investors must attempt to identify which novel technologies and applications will result in the large-cap companies of tomorrow.
In health care, Janus sees large growth potential, as meaningful gains are made toward finding long-term treatments for previously incurable diseases and extending lifespans.
Equity Portfolio Manager Andy Acker, CFA, believes the next wave of innovation will come from combination therapies, which often involve recently approved biomedicines.
“The reason why this is so important is that there is the opportunity to develop long-term functional cures in previously incurable cancers,” Acker said.
According to the report, health care investors should concentrate on active managers who invest in firms identifying original therapies that are sufficiently differentiated from the current standard of care to merit coverage by government programs and insurance providers.
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