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The X factor for shares in 2017
ASX Investor Update asked three investment experts to name a potential X-Factor or Black Swan event for markets in 2017 – an issue or theme that few investors saw coming.
Equities Strategist, Bell Direct
There are many positives to focus on in 2017: the revival and momentum of the commodity market, reinflation strengthening growth areas and stimulus by the Chinese Government that has helped the Australian economy.
But with the market rallying since Donald Trump’s election victory in the United States, it can be easy to get lost in the positives of the market and overlook potential risks.
While valuations in the US sharemarket is one to keep an eye on, most investors are already informed. The region I am keeping a close eye on is Europe: the eurozone has the X-Factor for portfolios in 2017.
The problems are so vast, from Italy’s non-performing loans and banks, Germany’s vulnerable Deutsche Bank and the continued bailouts required by Greece. All these problems have been simmering in the background for years, so why do they have the potential to again come to the forefront of markets in 2017?
In 2017 there will be a raft of federal elections in Europe, the key ones being the French presidential election in April and the German election in September. These potential changes in power come at a time when we have witnessed upsets to the status quo in the form of Brexit and US President-elect Trump, and at a crucial time for the eurozone to consolidate its commitment to the economic region and currency.
Eurozone growth is slowly crawling along, but the social costs of the region are escalating, with youth unemployment posing a problem. Unemployment for those younger than 25 is staggering in countries such as Spain (44 per cent), Italy (36 per cent), France (25 per cent) and overall in the euro area (21 per cent). It is just another statistic reflecting the social discontent that could see instability return to the forefront of global concerns if we see significant shifts in eurozone power.
I am cautiously optimistic for 2017. With the US sharemarkets recording all-time highs, investors must treat this like a bull market until proven otherwise. The area that makes me nervous is the eurozone and I’ll be keeping a close eye on the elections and what they mean for the investing environment and my portfolio.
CEO, Fat Prophets
The big surprise in 2017 will be global bank stocks. Sentiment has been very depressed for some time towards the sector and this has led to ultra-cheap valuations (we have bought many bank stocks that have been selling for less than their book value). In addition to an ultra-low interest rate environment, high regulatory burdens and post-GFC legal expenses have also weighed on global bank stocks.
However, with the US yield curve steepening, and the consequential impact around the world, I believe banking margins should stabilise and rise. The housing market (lending revenues and bad debts) remain a key risk to the banks, but with many “cooling” measures well underway (including in Australia), governments and regulators will continue to engineer a soft landing. I can therefore see bank stock valuations reverting towards the historical mean in the year ahead.
Yet the market consensus view (and from investment banks themselves) remains underweight the sector. In the US, this is despite the fact that Trump’s policy agenda is more “bank friendly” than it would have been under Hilary Clinton.
In Japan and Europe, negative interest rate policies have weighed on earnings, but this has already played out and governments are more cognisant that strong economies require strong banks. There has been plenty of concern over their financial stability, and particularly in Europe the pessimism has been excessive, given no bank has failed on the Continent since the GFC.
In Australia, there has been scaremongering over potential dramatic dividend cuts in banks, but this has proven a non-event. In the meantime, the banks have been upping their lending rates.
When we do start to see official interest rates rising, there are likely to be earnings upgrades across the banking sector. This will probably see a scramble (and some pain) for funds that do not own enough bank stocks.
The “big short” on the banks could well become the “big long”, and fairly quickly. The real short play will be the bond market (I think it will become the most hated asset class in 2017). But that’s another story…
Founder, Intelligent investor
Who would be a forecaster these days? In politics, an entire industry grew up around the idea that the results of elections were predictable. Yet pollsters, journalists and party insiders got Trump and Brexit wrong. Finance isn’t much better. Can you recall someone forecasting the recent rise in commodity prices or bond yields? No, me neither.
We are in such an unusual period, politically and economically, that forecasting is a gold-embossed invitation to look stupid. That doesn’t mean thinking about potential surprises this year is a waste of time, only that it calls for a different perspective.
It is conceivable that Russia invades Ukraine, that China holds a democratic election and that the Mexicans build a wall (to keep Trump out, perhaps). Plenty of things could happen this year, some of them likely even, that no one is thinking about.
That’s the problem with so-called Grey Swans; with so many up in the air it’s better to simply call them risks and not get bogged down in their individual features. As for Black Swans – Donald Rumsfeld’s unknown unknowns – by definition, they are beyond our reach. Things happen, and most of the time we do not know what they will be.
In that sense, 2017 is unlikely to be that different from 2016. Stuff will happen that no one expects. But try to structure your portfolio for one of those risks and it may increase your exposure to another. Tricky, right?
Instead, it is better to prepare for the unexpected than try to forecast it. That might mean, for example, you examine your overall exposure to the big banks. Many of the risks Australia faces would impact this sector and yet too many investors still have 30 per cent or more of their portfolio allocated to it. That’s a risk many investors are unconsciously taking.
So too is an over-exposure to investment property, especially in Sydney and Melbourne, where on many measures property prices lead the world. After 25 recession-free years, have we forgotten that property markets fall?
And too many investors haven’t diversified their portfolios away from Australia. International investing remains a boutique activity, when it should have become more mainstream.
These are the risks investors are forgetting but can do something about. It usually pays to focus on the things you can control rather than speculate on the things you can’t.