The New Year has gotten off to a positive start, with equity markets benefitting from investor inflows, following the closing of positions and profit taking seen towards the end of December. The bull market seen in equities, in the last quarter of 2016 could be expected to spill over into the first quarter of 2017 as a number of material factors seem to favour equities over bonds for the coming year.
The bull market seen in equities, in the last quarter of 2016 could be expected to spill over into the first quarter of 2017 as a number of material factors seem to favour equities over bonds for the coming year.
Since Donald Trump’s election in the US, perceived favourable fiscal spending measures and lower income taxes have accelerated outflows from bonds into equities, following the Federal Reserve’s rate hike in December and three further planned rate hikes for the year ahead.
GDP growth and inflation expectations have taken a boost since president-elect Trump’s victory and government and municipal bonds are set to take most of the impact of bond sell-offs.
It is worth noting that when an economy grows or is expected to grow, bonds, namely investment grade issues, sell off in favour of higher yielding assets, such as equities or high yield corporate issues.
Treasury Inflation Protected Securities, however, are a hedge and an option for those investors not willing to divert away from government bonds in a rising interest rate environment.
In a rising rate environment, high yield bond issues offer relative value in terms of yield, yet the higher interest rates rise, the higher the probability of corporate defaults that arise for sub-investment grade issuers.
Equities could be said to offer the most reasonable risk-reward trade-off at this point. High yield fixed income should not be cast aside, however, as their higher coupons reduce the downside risk compared to their investment grade counterparts in a hawkish environment. It is imperative that adequate bond picking and fundamental analysis of the underlying issuers are conducted nonetheless.
Although Fixed Income sell-offs are picking up worldwide, we could nonetheless expect subdued yields for a while longer as corporate issuers, notably in the US, will try re-finance in the currently low interest rate environment before subsequent Fed Rate hikes occur.
Furthermore, Japan is expected to prolong purchasing its own government bonds in the hope of sustaining rising interest rates to around the 0% mark, all in the hope of maintaining exchange rate stability with the USD for trading purposes.
Europe can still expect loose monetary policy measures in 2017. The political agenda, consisting of a number of general elections and the triggering of Article 50 for Brexit should bring with it uncertainty and volatility, as one lesson learnt in 2016 was to never trust the polls!
Anti-Europe movements have been gaining popularity over recent years and risk putting pressure on the EUR against a number of peers. Should this happen, I would not be surprised if the ECB diverts away from tapering and reverts to accommodative measures to support the Euro currency and boost inflation expectations.
The oil market will also be interesting to monitor, as oil prices will have a big say on inflation expectations. Whether Russia, Saudi Arabia and other Opec and non-Opec members stick by their word of ceasing production will be a big determinant of whether the supply glut is ceased once and for all, paving the way for improved inflation and global growth expectations past 2017.
Disclaimer:
This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.