What the first half of 2017 could mean for the second

The first half of 2017 is already behind advisers and clients amid a whirl of trends, counter-trends, political ructions and central bank double-speak. Key macroeconomic and geopolitical highlights have included:

  • Two interest rate increases by the US Federal Reserve (the third and fourth of this upcycle) and heavy hints from Chair Janet Yellen that the central bank is about to start withdrawing Quantitative Easing.
  • Reassuringly healthy headline growth numbers from China, a string of positive economic surprises from Europe (despite more bad news from the EU’s beleaguered banks) and a mixed bag of indicators from the USA and the UK, where first-quarter GDP growth disappointed.
  • A slide in the dollar to nine-month lows, on a trade-weighted basis, accompanied by gains for the pound, euro and Chinese renminbi.
  • A fresh decline in the oil price.
  • Further decreases in unemployment across the West but without the expected acceleration in wage growth.
  • Increases in the headline rate of inflation in the UK, USA, Japan and Europe, although how much of this was down to oil remains open to question.
  • The inauguration of President Trump, after which point the number of tweets sent far outweighed the amount of legislation passed, as visa embargos, healthcare reform, infrastructure spend and tax reform all ran into the sand.
  • Defeat for anti-EU candidates in France and the Netherlands and a hung parliament in the UK after a snap General Election.

Markets in pictures

Markets appear to have taken this all in their stride, with the consensus view that equities would do well and bonds less well coming out on top.

On a total return basis, global equities offered positive returns while bonds did not and commodities did worst of all:

Stocks outperformed bonds and commodities on a global, total returns basis in the first half

Source: Thomson Reuters Datastream

Within equities, Western Europe did best, buoyed by further Quantitative Easing from the European Central Bank and increasingly upbeat economic data, as well as victory for pro-EU parties in the French and Dutch elections.

In total-return, sterling terms Asia came next, helped by a rally in China, and then the UK, with America among the laggards, hampered by lofty valuations and logjam in Washington. Eastern Europe, weighed down by soggy oil prices, brought up the rear:

Western Europe did best and Eastern Europe did worst in the first half of 2017

Source: Thomson Reuters Datastream

By sector, energy was the one grouping to provide a negative total return in the half, owing to the second-quarter slump in oil.

Secular growth plays technology and healthcare did best, to suggest there are still some misgivings over the strength of the cyclical upturn, even if industrials ranked third out of 11 sectors in the S&P Global 1200 and financials fifth:

Technology did best and energy did worst on a sectoral basis in the first half of 2017

Source: Thomson Reuters Datastream

In terms of bonds, inflation did squeeze higher and central banks began to talk a tougher game, the US Federal Reserve raised rates; the Reserve Bank of Canada discussed doing so; three members of the eight-strong Bank of England’s Monetary Policy Committee voted for a rate rise in June; and the European Central Bank faced more questions than ever about whether it would halt QE in December.

The prospect of an end to QE in the EU hurt German bonds, where yields have dropped into negative territory, but emerging market paper still offered positive returns, as did junk bonds in the UK, EU and US, in sterling, total-return terms, as the reach for yield continued apace:

High yield and emerging market debt did best of the fixed-income sub-classes in the first half

Source: Thomson Reuters Datastream

Five themes for the second half

Overall, the picture is indistinguishable from much of 2016 – low volatility and generally rising ‘risk’ asset prices, amid faith in central banks’ ability to manage the cycle.

At least the five themes highlighted by this column back in January as key to the year still look relevant as a result.

By way of a reminder, they are as follows, with additional thoughts in bold type.

  1. The dollar and whether President-Elect Trump’s fiscal policies and the US Federal Reserve’s monetary ones drive up the US currency to fresh heights.
  2. Trump is getting nowhere fast and the Fed is raising rates but the dollar does not seem to care. Since a strong dollar is inherently deflationary for the rest of the world this is possibly no bad thing.

  3. Bonds and whether rising growth and inflation expectations inflict further damage on the fixed-income asset class after a 30-year bull run.
  4. Bonds have struggled in the first half, although inflation began to cool again in May and June and the oil price rise effect will begin to drop out from now onwards. Further rate hike talk from the Fed (or other central banks, like the Bank of Canada) could keep fixed-income on the back foot, even if deflation is by no means defeated.

  5. Emerging markets and whether they can continue their outperformance of 2016, with the dollar and commodity prices likely to play important roles here.
  6. The dollar helpfully weakened in the first half but commodities did so at the same time (rather unusually). This hampered Eastern Europe but helped Asia and overall Emerging Markets continued to do well.

  7. Brexit and the shape the British Government’s negotiating position takes.
  8. Oh dear. This looks messy but it is not, as yet, unduly hampering returns from UK stocks which are underpinned by a forecast 4% dividend yield. Sustained sterling strength for a multi-national-packed FTSE 100 could be an encumbrance in the second half.

  9. Banks and whether they can maintain their good run in the second half of 2016, helped by a swing from expensive defensive and quality growth stocks toward cyclical and value plays.
  10. Financials have had a good first half which is a good sign, as is the manner in which the US Federal Reserve’s latest stress tests passed all 34 banks for the first time in seven years (even if it might one day regret permitting further share buybacks and dividend payments). The collapse of two Italian banks and one Spanish one in quick succession in June does however suggest Europe’s banks are not as robust as everyone would like to think and this must be watched closely.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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