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. 9 of the 12 cheapest markets are from 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
GDP growth has accelerated year over year since the first quarter.
However, the US Dollar has not remained strong.
The S&P 500 has returned, on a percentage basis, high single digits since the beginning of the year. The below chart is the S&P500 with Jan. 1, 2017 set at 100.
The Yuan has strengthened on the year. The Chinese appear to have been successful, so far, in supporting their currency.
The MSCI Emerging Market Index did choose to include Chinese stocks, which should cause money managers to increase their allocation towards Chinese equities. The Shanghai market is up 3.7% on the year and Chinese stocks still rank well on valuation metrics (see the chart in the European section).
German and French GDP growth have increased since the beginning of the year, however, the strength has declined.
Surprisingly the periphery of Europe have mostly also increased (Spain is the exception). For brevity I am just showing the so called PIGS (Portugal, Italy, Greece, and Spain).
In France, populism did not take hold with Emanuel Macron, and not Francois Fillon, willing the election and this bodes well for Angela Merkel. This has made the Euro forecast likely wrong. The Euro has actually been strong on the year.
European stocks have been strong this year suggesting they did represent value earlier in the year and still inexpensive based on valuation metrics, where 12 of the top 20 inexpensive markets are European.
Canadian GDP has been accelerating in 2017.
The Loonie is approaching the highest level of the year on the recent appreciation.
Using the purchasing power metrics from the Economists Interactive Big Mac Index, the Loonie is still undervalued by approximately 9% vs. the USD.
However, the Toronto Stock Exchange has underperformed the S&P500 year to date.
- 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.
Volatility remains low but has risen from the lows earlier this year and so far trade wars have not materialized, only the constant talk of them on TV.
The VIX and More blog has some written some interesting articles on volatility cycles. It appears low volatility begets low volatility until it doesn’t.
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.
Reflation is at a make or break point. Commodity prices are higher than early 2017, but have weakened recently.
Oil has been range bound but the grains have rallied. Could this reaccelerate reflation?
- 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.
Both Copper and Oil have traded down with the dollar this year, and gold has joined this trend. I believed they would trade upwards with the dollar. The correlations have become positive, but the direction has been the opposite of my expectations. Stocks and the USD have not had a positive correlation.
USD to Copper
USD to Oil
USD to Gold
USD vs. Stocks
- 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 5-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.
- Best Performing Markets
This has not been true. Australia and Canada have lagged, Ireland and the UK have been alright with the USA and India having very good starts to the year. I will revisit this prediction in more detail at the end of the year.
- 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.
- Political Risk Premium
Unrest and instability have been a common theme this year, but this was really a second half trend. It is too early to make any conclusions.
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.
So far this has been correct. The US Leading Indicator is near an all-time high.
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.
Le Pen lost in France, Wilders lost in the Netherlands suggesting the trend in populism has peaked. Later in the year we will see if this carries over to Germany.
FED falls behind curve by half 2 of 2017.
Inflation has been slowing during q2, but this is more of a second half story for 2017.
The following teams will win the Stanley Cup, the World Series, the NBA Championship and the Super Bowl (Feb 2018):
Leafs, Warriors, Yankees, Raiders
Of the completed championships I am 1 for 2.
Leafs (WRONG) Warriors (RIGHT), Yankees, Raiders
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 – ISIS grip on Mosul has recently been reduced to almost nothing and Trump and Putin appear to have a coordinated strategy. The internationally backed government in Libya is making major gains as well. This may turn out to be true but it is too early to make a definitive comment.
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