I’m cautiously optimistic about investor prospects this year, but unpredictable geopolitical events could cause turmoil.
We’re a month into 2017 already, and it could be an interesting year – but first let’s look back at 2016.
There was a downward trend in the share markets at the start of the year largely due to concerns about China and, to a lesser extent, geopolitical issues in the Middle East.
When the American market opens on a negative trend, it typically struggles for the rest of the year.
Last year was no different, with international share markets remaining flat until later in 2016 when returns improved.
Brexit in the UK and the election of Donald Trump in the United States did not impact the markets as analysts feared.
The reverse occurred, with the London FTSE rising on the back of a weak UK pound, and the US market rising on the back of Donald Trump’s policies on building infrastructure.
The main concern for 2017 is the rise of populism, nationalism and anti-globalisation sentiment, but more on this later.
The New Zealand share market, while overvalued, continued to rise to 23 times the price-earnings ratio by late 2016.
By about October we saw offshore investors taking profits and the New Zealand market retreating, only to recover in December and January.
The bond market was a real concern last year, with the potential rise of long-term interest rates forcing negative rates to occur late in the year.
To protect investors from this predicted long-term scenario, a move to short-dated bonds was necessary, while keeping an underweight position in this asset class.
As we took a more conservative position in 2016, cash returns had a suppressing effect on overall returns, though cash maintained a better position than bonds in terms of a real rate of return.
What about this year?
So what does 2017 hold? The main concern for markets will be geopolitical issues.
I have held a long-term view that geopolitical issues have a considerable impact on markets. It is now being recognised that markets may well be affected by this.
The rise of populism, nationalism, and a strong anti-globalisation sentiment may impact markets in 2017.
But the uncertainty is which one of these issues will drag the markets down.
Will nationalism cause interest rates to rise? Will right wing governments occur in Europe on the back of populism?
Conversely, taking into account how markets reacted to Brexit and Donald Trump, the very reverse may occur.
However, it is the potential of a ‘black swan event’ that could cause a major correction in the market. A black swan event is the unknown factor, and as such, we do not know when or what this will be.
So it is the political uncertainty that may cause the volatility in the markets.
International, New Zealand and Australian share markets have had a good start to the year.
This is much to do with the positive sentiment around Donald Trump’s call for infrastructure building. It has led to a rise in commodity demand, and we remain bullish on commodities going into 2017.
China has stabilised, though concerns still remain around the country’s debt. China’s improvement will benefit Australia and our early position of moving into Australia may be paying off for 2017, as we saw strong gains in this market in late 2016.
New Zealand fund managers have also weighted their Australasian portfolios more to Australia. We continue to remain cautious on New Zealand and international shares as we still have concerns on the long-term upward trend of international shares.
This is as much to do with political instability as anything else, as well as with United States considering increasing interest rates in 2017, which always has a drag on the share market.
Following on last year’s bond market issues, we have been attempting to reweight client portfolios to short-dated bonds to protect them against these increased risks in 2017.
There are a variety of issues occurring in the bond market that will affect conservative investors. There is considerable debt (both sovereign and corporate), with Italy being the new concern in this area. The Italian banking system has long been a problem, and we may see Italy becoming more problematic in 2017.
Further, with long-term interest rates reaching the lowest point in August 2016, we are now seeing, as predicted, negative bond rates around long-dated bonds.
While in the long-term investors may benefit from this in terms of interest rates, these bonds will come at a premium.
So we continue to underweight in bonds and go short where possible. This policy will hold through 2017.
We still remain positive on cash even though interest rates are low at the moment.
With possible inflation expected in 2017, we may see a rise in interest rates. Further, cash has a positive return over bonds, and is a bailiwick against a falling share market.
Finally, we remain positive on infrastructure, although neutral on property.
With rising interest rates the yield on property in New Zealand and overseas may be suppressed.
I am cautiously optimistic for 2017, as there are no known issues that will drastically affect the markets.
However, a black swan event could cause turmoil in the markets.
It is this we have to be wary of, as there are so many issues in the geopolitical world that could cause problems for investors in 2017.
So while I am happy to weight portfolios more to the up side, this should be done with caution and a view to remain slightly underweight where possible in shares and bonds.