Paul Jackson, head of research at ETF provider Source, gives us seven unlikely, but possible investment scenarios for this year, including a US recession and Brexit chaos.
The biggest returns are earned (or the biggest losses avoided) by successfully taking out-of-consensus positions (or avoiding the errors made by most others).
It is time to forget central scenarios and think about improbable but possible outcomes – what might surprise us in 2017. These are not central scenario views; rather they are ideas seemingly ignored by the markets but where we think the probability is at least 30%.
· The Mexican peso stages a recovery
The Mexican peso has fallen about 25% versus the dollar in the last 18 months, partly because of Donald Trump’s anti-Mexican rhetoric. But given that his bark may be worse than his bite and that the real value of the peso is approaching levels seen during the LatAm and Tequila crises of the 1980s and 1990s, this could be a good year for the Mexican currency.
· The US economy tips into recession
A year ago fears of a US recession were rife. Now it seems hard to imagine, which is exactly why it is worth considering. Q3 was the 29th quarter of this economic expansion, which is the average length of those since the war. The risks are rising, especially as the Fed tightens and the dollar appreciates.
Corporate profits play a key role in the cycle and, though Trump may boost after-tax profits by cutting corporate tax rates, his policies could shift income from capital to labour (the attempt to create more jobs in a fully employed economy could raise wages rather than profits). Investment could easily fall. Gold would enjoy a US recession.
· Brexit chaos; Theresa May resigns; £ hits new low
Sending the Article 50 letter will start a process about which the UK government appears clueless. The loss of jobs to Europe, lack of engagement from European leaders focused on their own domestic politics and agitation from Scotland and other “Bremainers” will provide a potent cocktail. Theresa May appears indecisive and could buckle under the pressure. In the midst of all this, sterling could test new lows.
· Italy launches an EU referendum process
This year’s elections in Europe have the potential to provide some upsets and there is a non-negligible chance that another European country will hold a referendum on EU membership. The most likely candidate is Italy. We suspect it will hold a general election in 2017 and the populist and anti-EU 5-Star movement is closing in on the ruling Democratic Party in the opinion polls. If an EU referendum is called we suspect the “safe-havens” will do well: gold, Swiss francs, bunds and US treasuries.
· Emerging market debt outperforms again
Despite the best efforts of Donald Trump, emerging market debt was one of the best performing asset classes during 2016. This still leaves it well behind on a three- and five-year basis. Yields are well above those of the developed world, while debt metrics remain superior.
· Chinese A-shares outperform major markets
After the drama of 2015 and the opening days of 2016, Chinese A-shares have been rather calm. Industrial profits were falling during 2015 but were on the up throughout 2016, with a gain of 14.5% year-on-year in November. Despite Trump’s threats and the fact the central bank now appears to be tightening, we think that a P/E ratio of 9.7 and a dividend yield of 2.9% makes the FTSE A50 an enticing prospect. We believe that MSCI still wants to add China A-shares to its Emerging Market index and this could be the year.
· Oil falls to $20
Our analysis suggests that since 1870 all price cycles have finished at $20 in today’s prices. Opec has convinced many that it can limit supply but let’s see how that works out as the year progresses.
©2017 funds europe
