As we begin 2017, it is valuable to take a minute to sit back and reflect on the past year. To say the least, it was quite a year. In fact, some have termed it the year of the “unexpected” with Britain voting to leave the European Union, Donald Trump defeating Hillary Clinton in the Presidential election, and the Chicago Cubs winning the baseball World Series. Yet, to define the year with such a single theme would not do justice to the wide spectrum of events, both positive and negative, that we have witnessed. One only needs to think of Pope Francis’ world tour of mercy, exploding Samsung phones, the attempted military coup in Turkey, the impeachment of President Rousseff in Brazil, the spread of the Zika virus, the deaths of Fidel Castro and Mohammad Ali, and the announcement that Harriet Tubman’s image will replace that of Andrew Jackson on the $20 bill to appreciate where we have been. Yet, even as we think about 2016, we look forward to what will come in 2017.
As the common dictum goes “the past is where you learn the lessons, but the future is where you apply the lessons.” What lessons can we, as investors, take with us as we enter into the new year? We see two major lessons: first, that we are often surprised by individual events and that some of these, such as the British vote to leave the European Union or the election of Donald Trump, can have significant short-term effect on markets; secondly, that macro trends are just that – macro and tend to influence markets over time despite short-term surprises.
We believe there are five macro topics from 2016 that can help investors track a successful path within an increasingly noisy world:
- Interest Rates: The Federal Reserve, under the leadership of Janet Yellen, announced in December that the key interest rate would rise by 0.25%. While this increase was modest, it is important because it marks the second time in over a decade that the Federal Reserve has been willing to make such a move, signaling growing confidence in the strength of the US economy. If the Federal Reserve pursues subsequent interest rate increases, as they have indicated is their plan, then the financial sector, in particular, will benefit from the rise in interest rates as banks earn revenue on the spread between what they pay to depositors and what they are able to earn on loans. Contrastingly, the real estate and utility sectors, which historically have high debt burdens and pay high dividends, will become less attractive as the interest payments on their debt grows and investors move their assets into other investments as the rate of interest they yield becomes more competitive with the dividend rates of these companies.
- American Fiscal Policy: Although there is still some uncertainty around what the agenda of President Trump and the Republican-led congress will be, there are strong indications that there will, at a minimum, be a focus on deregulation and lower corporate taxation. Deregulation will help the healthcare and financial industries which have been investing significant resources since the 2008 market crash in both fiscal and human capital to comply with an increasingly complex regulatory environment. Tax deductions, meanwhile, will be beneficial to American corporations as a whole. Currently, the US has one of the highest corporate tax rates in the world. If there is a dark cloud to this story, however, it is that rising interest rates will increase what the federal government pays to borrow money, and lower taxes will likely result in less tax revenue in the short run. The net result could be a ballooning federal
- Inflation: Inflation in the US is now around 1.7% and is expected to continue rising to just above 2% in 2017. Historically, inflation occurs when the market is growing and companies begin to charge higher prices for the products they sell, or when there is an expansion in the amount of money being circulated in the market. While we do believe the US economy is growing, we also think that inflation will rise, in large part because of the billions of dollars that the Federal Reserve pumped into the economy during the recovery. Up until now that money has largely been on the sidelines but may be increasingly in circulation in 2017. In general, we believe that higher inflation should encourage investors to allocate assets more heavily in equities, which rise with inflation, rather than bonds, which pay investors at a fixed rate. Similarly, TIPS, or Tbe more attractive as investors, particularly those in need of consistent income levels, demand more safety.
- China: The Chinese economy continues to slow from the average 10% annual GDP growth rates of the early 2000s. Since 2008, the Chinese government has tried to counter the decrease in exports and rising value of the currency by pumping debt-financed money into less efficient state-owned enterprises in an attempt to avoid an economic downturn and leading their country’s debt level to skyrocket to over 250% of the total annual GDP. Consequently, foreign investors and the Chinese elite have continued to move capital out of China. For example, in 2015 over $670 billion dollars in investments flowed out of the country and this trend appears to have accelerated in 2016. While we continue to believe that China is a good long-term investment, we believe that recent economic developments, combined with the likelihood that there will be an increasingly unstable US-China political relationship, warrant caution in the near term. As a result, we would avoid industries, such as those connected to the commodities industry, which rely heavily on a thriving export-driven Chinese economy.
- Europe: Britain’s decision this past summer to leave the European Union signals a new phase of uncertainty in the region unlike anything seen in the past two decades. While Britain will still be a dominant economy, we expect that the European Union will try to make the separation painful in an attempt to show other members that departure from the Union is not an option. Unfortunately, however, the region has a significant number of other obstacles it must deal with, including an extremely fragile Italian banking system, an aging population, the rise of right-wing extremist political parties, terrorism and the rise of a more aggressive Russia to the East. If on top of these challenges, should Germany’s chancellor Angela Merkel, who has been acting as a supreme leader in the region, lose her re-election in 2017, we can expect a period with a leadership vacuum. While this does encourage some caution and makes the US market comparatively more attractive, we do see selective opportunities in some European blue-chip equities, ETFs, and mutual funds that are less expensive on a historical basis and provide yields of between 3% and 7% as a result of their discounted prices.
At Glen Eagle, we recognize that no one can accurately predict the future in detail, but we do believe that by understanding the past and analyzing the present, one can pave a path to successful investing. We hope that the above five topics, although not fulsome of everything happening around us, is helpful to you as you think about investment opportunities in this new year. If 2017 is anything like this past year, it should be quite a ride. We look forward to helping you navigate the ever-changing environment.
Wishing you a prosperous 2017.
Susan McGlory Michel
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.