Last year was a tumultuous one – in terms of politics, but economies around the world were mostly steady and inflation was well behaved, so after all was said and done the financial markets did just fine.
After the results of an extraordinarily contentious election came in, U.S. stocks began pricing in the benefits of potential tax cuts and increased federal infrastructure spending and rallied accordingly. These factors have overshadowed the anti-trade rhetoric and confounding tweets of the President-elect.
The S&P 500 gained 5.0% after the election, bringing returns in 2016 to 12.0%. Emerging market equities sold off post election, but still managed to post healthy 11.2% gains for the year. Europe was thrown off-side by Brexit and persistent worries about its banking system (especially the Italian banks). The Euro Stoxx 50 index was pretty much flat for the calendar year.
Bonds took it on the chops in November and December with rates in the U.S. jumping almost 1% on the ten year Treasury. It ended the year at 2.44%, up about 15 basis points from a year ago and well above its 1.35% summer lows. Reasons included anticipation of stronger growth and higher inflation in 2017. Additionally, a more hawkish Federal Reserve that raised rates in December, and forecast three more hikes in short term rates next year, didn’t help matters. Still, the Barclays U.S. Aggregate Bond Index posted a positive 2.6% return last year, partly due to the good performance of corporate bonds.
Commodities turned up last year after a brutal decline brought many prices to ten year lows. After bottoming at $26 a barrel, oil perked up as the OPEC cartel reached an agreement to reduce supply. Oil ended the year at $53.
Francis Fukayama penned The End of History and the Last Man in 1989 just after the Berlin Wall collapsed. It proclaimed the death of communism. The markets, free enterprise and liberal democracy had won. The Cold War was over. It was a unipolar world and the U.S. was top dog.
Nations embraced new ways of doing business and shifted away from state planning and closed economies. Globalization took off. The EU adopted the euro and many multilateral WTO trade deals, including NAFTA, were embraced. Global trade increased dramatically bringing many out of poverty and driving up living standards and the financial markets. What’s not to like?
Well, some were left behind as global supply chains accessed cheap labor to improve “efficiency”, lower prices for consumers, and fatten profit margins. Good for stocks, but what about the impact on workers at home?
Not enough attention was paid to the negative side – mainly the loss of blue collar manufacturing jobs in developed countries. Certainly some of this can be attributed to technological change, but outsourcing jobs to China and other “low cost producers” were surely factors as well.
Recently other issues have been bubbling up, including the increasing role of government (perhaps due to the panic of 2008), and the loss of national sovereignty – having a say over one’s destiny. Political analyst Michael Barone notes:
“Overall history is not bending toward happy acceptance of ever-larger government at home. Nor toward submersion of national powers and identities into large and inherently undemocratic international organizations”
Over the past several years we have seen a rise in populism and nationalism throughout the world. There has been a backlash against global trade, illegal immigration, and rule by multinational organizations like the EU, where policy is driven by a “bunch of unelected bureaucrats in Brussels.”
The Brexit vote to leave the EU and the election of Donald Trump were manifestations of these trends. They’re not going away. Elections in France and Germany this year will show how much anti-establishment sentiment exists in those countries and whether or not this global trend will continue. While unlikely, an anti-EU populist win would send shock waves across Europe and threaten the euro. The long run future of the euro remains uncertain and in the short run a break-up would certainly be painful and messy.
Global trade has flat-lined of late. If this continues or we see trade barriers erected it would mean less global growth and higher inflation on the margin. While these outcomes remain a possibility, markets see them as unlikely and have not priced in such events.
As the New Year begins APCM is busy revising its current long term capital market assumptions. The current increased level of geopolitical uncertainly is a growing factor in the persistent but slow level of global growth that has been one of our themes for the past several years. Continued global economic growth is the base case scenario for 2017, however the potential for policy errors and an associated increase in volatility remains. We look forward to sharing the results of our updated long term outlook with clients in the coming months.
Thanks for your business and trust in having APCM manage your money. Here’s to a happy, healthy and prosperous 2017.
Jeff Pantages, CFA®
Senior Vice President, Investments