Market Wrap 2016

The past year has seen an unprecedented series of political events that have substantially increased the volatility across all sectors.

The year kicked off with the fallout from the Fed’s decisions to raise rates for this first time in nearly a decade. While Janet Yellen expressed a desire to raise rates by 0.25% four times in 2016, in the end the Fed managed just one rate rise.

The rate rise in December 2016 was a very different story to the rate rise of December 2015. Markets closed higher after the move. Principally this seems to be caused by two main factors; firstly, emerging markets like China are in a much better position to handle a rise in the borrowing costs on US Dollar denominated debts than they were 12 months ago many emerging economies have been rapidly deleveraging overt the past 12 months and the rise was well anticipated.

Secondly since the fall out at Deutsche Bank this year, markets have become increasingly worried about the effect of zero interest rates on the banking system. Banks like Deutsche have seen their lending margins squeezed from around 4% in 2007 to 2% today.

With interest rates rising much of this pressure is likely to fall away from the global banking sector sending shares higher.

While at the start of 2016 we saw risks from China and the US interest rate rising cycle as being the big news stories the reality ended up being very different.

Firstly, we had the United Kingdom’s shock result in the referendum on EU membership. This saw the pound crash to a 30 year low against the US dollar and wiped nearly 10% of the FTSE 100 index over night. Fortunately, on the day of the crash our portfolios were heavily in cash and defensive assets and we could purchase back into markets at lower levels.

Subsequently the FTSE 100 has since gone back up reaching an all-time high. However much of this gain is due to the low value of the pound. Most FTSE100 companies earn in US dollars making profits appear higher in Sterling terms. In addition, rising oil prices and the boost to banking stocks have all given the FTSE 100 a lift.

UK markets and the pound in general are likely to remain volatile while the UK’s future relationship with the single market is negotiated over the next two years. There are likely to be significant buying opportunities as the UK heads towards enacting article 50 of the Lisbon Treaty. While the UK pulling out of the EU is all but a done deal, there may be interesting developments in regards to the UK’s membership of the European Economic Area and single market.

It seems certain that the Supreme Court will require the government to obtain the consent of parliament to enact article 50. It has also started to become apparent that the UK may need to separately enact article 127 of the EEA charter to leave the Single Market.

While MPs are certain to vote to respect the referendum result and leave the European Union it may be a very different story if a vote is put to them to leave the European Economic Area and the Single Market.

Any move that sees the UK more likely to stay in the Single Market will likely see the Pound and the FTSE 250 rise and the FTSE 100 fall.

In addition to the UK leaving the EU we have also had the shock result of Donald Trump winning the US presidential election. Markets have reacted well to this so far as it seems highly likely that US corporation taxes will be cut. In addition, relief may be given to companies holding large cash balances abroad that have not been remitted back to the USA.

Currently US companies are holding well over $2 trillion in cash in offshore subsidiaries. If companies repatriate this money and pay out special dividends we could see a substantial boost to both the market and the economy in the short term.

On the downside, Trumps comments on free trade agreements may serve to damage longer term economic prospects. The Trans Pacific Partnership or TPP is most certainly dead and NAFTA’s days may be numbered, although at the moment it seems that Trump may be happier to keep NAFTA if he can simply threaten US manufacturers with is removal to get them to re-shore jobs in the USA.

Trump’s election may also pave the way for a comprehensive trade agreement between the USA and the UK.

While there are some significant risks that may present themselves in 2017 the picture is much rosier than it was 12 months ago. The global economy seems to be able to live with rising interest rates, China has increasingly stabilised and the US Government looks like it will be able to start passing legislation for the first time in 6 years.

There remains significant challenges in Europe but these are more political than economic. With Italy moving to shore up its banks it seems unlikely that we will have a failure in the European banking system. The biggest potential issues are from a messy Brexit negotiation as well as the threat in France presented by Marie Le Pen.

We expect to see equities move higher across 2017 as well as bonds and commodities. Gold will likely remain flat.

Please feel free to get back to us should you wish to discuss your investments in more detail.

Duncan

Tel : +60320260286E-mail : Portfolio@Farringdongroup.com

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