Equity markets have continued the Santa rally into the new year, assisted by some encouraging economic data. Manufacturing purchasing manager’s surveys across Europe, including the UK have beaten expectations. The same can be said for the equivalent surveys in Asia. The Institute for Supply Management’s December reading for US manufacturing came in line with expectations, but at 54.6 continues to demonstrate an expanding manufacturing base.
Equity markets in the US were not rattled on Wednesday by the release of the minutes from the December Federal Reserve meeting which confirmed the only rate rise from the Fed in 2016, or weaker than expected numbers from two major retailers, Kohl’s and Macys. The minutes had a hawkish tone to them, as the Federal Reserve tries to gauge what impact “Trumponomics” will have on the US economy and inflation expectations.
2017 looks as if it will be a trickier year for investors, as trading themes look harder to identify. This time last year, there was a clear theme. Growth stocks remained in vogue as investors took the view inflation was dead. This led to the valuation gap between value sectors and growth sectors reaching extremes rarely seen in history. Starting 2017, expectations are for global growth to strengthen. Should it do so the rotation from defensives will continue into 2017, and markets should stay underpinned. If not, all equities will fall, just some less than others.
So, goes January, so goes the rest of the year, is another adage that stock traders believe and it does have some anecdotal evidence to support this belief. Last year the month of January 2016 saw equity markets retreat, in the end, as we now know equities had a decent year.
Looking out to 2017, economic growth is what ultimately drives equity markets. Valuations are important, but more so when earnings fall. Central bank’s policy actions are ultimately designed to stimulate growth in times of weakness, and introduce more contractory measures when they see inflationary pressures becoming a risk to the economy. Central bankers talk about “target inflation” what they really want to target is avoiding deflation. At present the central banks, Federal Reserve aside, are still employing expansionary policies. The Federal Reserve may tighten policy this year but they too are wary of damaging growth with too aggressive policy measures, as 2016 demonstrated. On that basis, global economies should continue to get a fair wind from central bankers in 2017.
What could queer the pitch? A sharper than expected pickup in inflation expectation in our view. We saw on Wednesday inflation ticking up in the euro area. This will create further tensions within Europe as Germany will push for the ECB should reverse negative rates. The consensus view amongst analysts is that there are enough global structural issues to prevent inflationary pressures taking hold. Should they be wrong this will pose a conundrum for Central bankers in 2017.