2017 Trend Outlook
In January I wrote about the trends I felt would impact 2017. With the half way point in the year I thought it would be a good exercise to review the trends identified.
- Economic Growth
USA – I believe the US expansion is late in the cycle and will see an acceleration of growth. The USD will remain strong with a bias to the upside. I believe the US stock markets will be volatile but finish with high single digit to low double digit percentage gains.
China – The Chinese economy will receive a boost from a weakening Yuan and the stock market will perform better than expected, as Chinese stocks are not owned by the masses. Soon the MSCI global indices will include Chinese stocks and this will require managers who try to replicate the index to purchase Chinese stocks. I believe some long term money is front running this trend.
Chinese stocks are the second cheapest (after Russia) on multiple metrics. The Cyclically Adjusted Price to Earnings is 12.8, a Price to Earnings of 7.2, a Price to Cash of 4.5, a Price to Book of 0.9, a Price to Sales of 0.6 and a Dividend Yield of 4.5%.
Europe – Growth will be bifurcated on the Continent, with the export nations (Germany and France) accelerating while the periphery slowing. The Euro likely trades below par with USD, furthering benefiting France and Germany. Merkel will be defeated and this leads to Germany reversing strategy and bailing out periphery. France stays off populism, but barely, with Fillon winning the election.
Is Europe bottoming? If so it could be an area of value. Nine of the twelve cheapest markets are located in Europe.
Canada – I think Canada benefits from US uncertainty and the acceleration of US growth. Canadian stock markets perform well due to strong industrial and base metal commodity demand, as well as better sentiment due to greater export opportunities for Canadian crude oil. Canada, although overwhelmed with debt and with a housing bubble in Vancouver and Toronto, will be viewed as political safe haven. For example, applications for enrolment in Canadian universities by US born students has expanded recently. Some of these students will remain creating a reverse brain drain. They also spend money. Tech companies are also looking at Canada after the Trump refugee ban. This will bring money and talent to Canada.
This trend drives the currency higher than expected in the first half of the year. The TSX outperforms US stocks.
The Canadian Dollar is still undervalued on a Purchasing Power Parity basis.
- Economic Growth – USA – GDP growth did accelerate in 2017.
However, the USD was weaker than expected and traded down all year. US markets were not volatile and finished up about 25%.
China – The Chinese economy achieved is GDP target and many of the underlying indicators have stabilized.
This was with the Yuan being strong all year.
Hong Kong stocks returned 37% while the mainland shares returned 8%. The MSCI indices did add Chinese stocks.
Chinese stocks are still cheap vs. other markets (See chart in the Europe section).
Europe – I didn’t get the individual ideas correct for Europe. The EUR did not trade to par. France did not elect Fillon, but did hold off populism, and she did not grow as fast as I expected. Germany was strong in GDP growth and Merkel came close to losing. The periphery was mixed with Spain, Portugal, Ireland and Greece (the PIGS…or was Italy “I”?) growing fast but Italy remained weak.
I continue to believe Europe is at a generational low. Many of the cheapest markets remain European.
Canada – I got a lot correct with my outlook for Canada. It is my home market and I guess I learn a lot by osmosis. The CAD did trade up to my 81c US target before retreating. Immigration (legal and illegal) did accelerate in 2017. The reverse brain-drain is a longer term trend, but underway.
What I did get incorrect was the view that the TSX would catch up and outperform the DJIA. This did not happen. It was a one way trade all year. Although both indices ended 2017 at all time highs.
- Increased volatility due to trade war lite
Volatility has been historically low but I believe that what I am calling “Trade war lite” and traders making decisions off Trump’s tweets will spark higher volatility. Either you ignore it and check market prices less often or you trade it.
2. Increased volatility due to trade war lite
If you measure volatility with the VIX then I did not get this one even close to being correct.
Reflation continues and this benefits industrial and base metals. Oil is range bound until later in 2017, unless the new Iran sanctions target oil. One concern I have, which is not founded in data but has crossed my mind is the effect of a bad crop harvest. The world has had a number of years in a row with good to excellent harvests leading to low food prices. If there were to be a bad harvest the reflation could accelerate.
Oil broke out in the second half of the year as expected. Commodities, in general, were strong.
The poor crop harvest may be a 2018 theme.
- Changing correlations
I think copper and oil will have a positive correlation with USD. The USD will also be correlated with stocks. In the second half of 2017 gold could rally with the US Dollar, as unrest, protectionism and a trade war lite could cause a global dollar shortage, pushing the dollar much higher. The decline in the Euro to par with the USD and weaker Yuan causes flight to USD and gold.
4. Changing correlations
The USD, gold and oil all declined together in the first half of the year and then the normal inverse correlations evolved over the second half of the year.
- Best Performing Markets
The English speaking nations (Australia, Canada, India – kind of English speaking- Ireland, UK, and USA) are the best performing stock markets. All these markets are near five year highs and may back off or consolidate during the first part of the year, but this is where I think the best risk adjusted performance comes from.
5. Best Performing Markets
I should have worded this differently. Nigeria, Argentina and Venezuela had better returns than the English speaking nations I mentioned, but do you really want to be invested in high inflation nations?
Ireland returned 9.5%. The 6 English speaking country sample returned about 22%. That likely underperformed a basket of EEM and Frontier markets.
- Political Risk Premium
Unrest in the US and abroad and the increase in sabre rattling will be a tailwind for commodities and oil. This really gets going in the second half 2017.
6. Political Risk Premium
As mentioned above, commodities and oil did well in the 2nd half of 2017.
No US recession in 2017. The leading and coincident indicators are still trending up. These indicators tend to peak and begin to decline prior to US recessions.
No recession. Could this be a 2019 story though?
Trump’s unpredictability dampens desire for populism. Le Pen comes close in France, but the French decide they do not want their own Trump. The same happens in the Netherlands and in Germany, although Merkel does not win.
Merkel won but barely and populism seemed to suffer a set back this year.
FED falls behind curve by the second half of 2017.
Based on the Taylor Rule the FED is behind the curve.
However, it is uncertain that the FED has fallen behind the curve when comparing CPI to the Fed Funds Rate. More will be known later in 2018.
The following teams will win the Stanley Cup, the World Series, the NBA Championship and the Super Bowl (Feb 2018):
Leafs, Warriors, Yankees, Raiders
I got the easy one correct.
Leafs (WRONG) Warriors (RIGHT), Yankees (WRONG), Raiders (WRONG)
Bonus – War on terror turns towards West winning due to brutal and borderline war crimes committed by Trump and Putin. I see this as the biggest “white swan” and believe it is not priced into the markets.
Bonus – Correct. ISIS has lost almost all its territory.
Including the bonus I was about 6.5 out of 11. Not great, not bad. Stay tuned for the 2018 road map.
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