Dear Clients, Colleagues & Friends,
As 2016 draws to a close it’s time to reflect on the year and look forward to 2017. This is the first in my quarterly newsletter series for Ardbrack Financial. Please feel free to circulate to anyone who might like to be on the list.
2016 has been quite the momentous year, with Brexit and the US Presidential election confounding expectations and causing wild gyrations across financial markets. The Irish general election proved inconclusive and left us with a Government that many expect will fail to fulfill it’s term.
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”
― J.K. Galbraith
I am certainly not getting into the business of forecasting, but I outline below some thoughts on what I expect to be important topics in 2017.
This is a particularly tough one with the uncertainty of President Elect Trump’s policies beyond what was a lot of noise in the election campaign. Generally countries appear to be looking more inward than at any point in recent decades (witness Brexit, the rise of right wing parties across Europe and the catchphrase “make America great again”). This is unlikely to be good for global trade, or for small open economies like Ireland.
Some likely major themes for 2017:
- Brexit: Article 50 expected to be triggered by March.
- US: Presidential inauguration on January 20th. Foreign policy completely unknown at the time of writing.
- China to continue expanding it’s activity in the South China Sea.
- Russia to continue to gain influence in the Middle East.
- French Presidential election: Francois Fillion is the front runner by a wide margin, but in elections anything can happen. A victory for Marine LePen would be a massive shock for markets, for Europe and potentially catastrophic for the Euro.
- German general election: With Mrs.Merkel running once again, will she be punished by voters on the topic of immigration? Will speculation about foreign hacking play a part? Will anyone pay attention to the pollsters?
- Dutch general election: Voters expected to punish current government for austerity measures and shift to the right wing party led by Geert Wilders.
- Europe has less and less influence globally as it’s economies remain mired in low growth / high unemployment and protest parties at the left and right fringes gain support at the expense of the establishment, a continuation of what’s been happening for several years.
2. The Pension Crisis
This one is not going away. Higher bond yields in the last quarter of 2016 help at the margin to relieve a little pressure on pension fund deficits. The big problem here is demographics; people living much longer in retirement, funded by proportionally fewer workers paying into the system. This pay-as-you-go nature of the state and public sector pension systems is an enormous problem waiting to happen. It will probably not come to the forefront in 2017, but will get worse.
Private sector pensions are in crisis too. Expect more defined benefit pensions to close in 2017, and many to try encouraging members to transfer out. These transfers suit some people for various reasons, but are not for everyone. Bottom line is to find out how your pension scheme is funded, and what it’s invested in. Contributing some of your earnings to a private pension that you control makes a lot of sense, offering attractive tax breaks and helping ensure a better retirement outcome.
The pension landscape can appear daunting. Providing independent advice for individuals and small business is our specialty. Give us a call to help us analyse your situation and explain your options in simple language.
3. Public & Private sector pay demands
This is a particularly hot and contentious topic in Ireland as 2016 draws to a close. Many people in the middle classes are squeezed and living from paycheque to paycheque. The cost of living for most has been rising way above the low rate of inflation (rents, childcare, insurance etc) and many are clamoring for ‘pay restoration’. The simple fact is that the State cannot afford to raise public sector salaries – It would lead to lower spending on public services and less recruitment.
This is going to be very tough for government, with populists promising more spending but not showing how this will be funded (More taxes? The middle class is already squeezed!). The odds are high for a crisis in Ireland’s fragile government during 2017.
4. Stock Markets
Valuations in developed market equities are expensive on many levels. On November 21st the three main US stock market indices closed at new all-time highs. This was the first time since 1999 that the S&P 500, Dow Jones and NASDAQ all made new all-time highs on the same day.
The narrative post Trump is that lower taxes in the US combined with increased government spending and less regulation will increase economic growth, boost inflation and result in higher stock markets and interest rates.
The FTSE in London recovered strongly from it’s Brexit inspired dive, standing +12% for the year at the time of writing, but not if your home currency is EUR where your return would still be in negative territory for 2016.
For investors as always, diversification is crucial. You need to understand the funds you are invested in and the risks you are exposed to. If interested, talk to us about our diversified portfolios.
In Ireland there was talk in November that the re-floation of AIB might be on the cards again for 2017, but I don’t see it happening. The banking sector in general across Europe remains in poor shape.
5. Interest Rates
Is the great bond bull market finally over after 35 years? click here for a long-term graph of US 10yr interest rates
Irish 10yr Government bond yields hit an astounding record low around 0.30% in summer 2016 and now sit at 1%, still incredibly low by historic standards. I would be surprised to see us test the lows again.
Debt levels are extremely elevated around the world, at both the sovereign and corporate levels. Central Banks own an enormous volume of bonds following years of quantitative-easing. Will they keep re-investing as bonds mature? There is a big question mark over the ability of debt markets to accommodate a significant increase in rates without a meaningful pickup in economic growth. Even modest increases in bond yields in highly indebted developed countries like Japan, much of Europe and even the US would cost a large additional chunk of government revenue.
ECB policy rates will probably stay close to 0% in the absence of much growth or inflation across the Eurozone – Good news for those on tracker mortgages.
In the US the Federal Reserve raised policy rates in December ’16 by 0.25% (new target range 0.50-0.75%) and forecast three more 0.25% hikes in 2017. This time last year they forecast four hikes in 2016 but only one materialized. Will they be right this time? If so, it would be the first time in many years, and they will continue to be driven by how the stock market trades, economic data and the strength of the dollar.
US interest rates matter a LOT for every financial market in the world. The Fed board currently has two vacant seats. Mr.Trump has been a very vocal critic of Fed policy. It’s likely that he will fill those seats with people keen to raise rates toward a more ‘normal’ level. Let’s see. I think it would be positive if he appoints people from industry who understand risk, as opposed to the PHD heavy board of economists the Fed has become in recent years.
6. Inflation & Oil
Inflation seems to be slowly picking up in the US, and to a much smaller extent in deflationary mired Europe. Oil has been trending higher since OPEC agreed to cut supply in December. However one might suggest some skepticism given previous breaking of OPEC agreements. Oil back above $50 will awaken US shale producers and remember, the US is not far from energy independence. There is also a large question mark around the strength of demand from China and other emerging market countries with the slowing of global trade.
The US dollar has had a stellar 2016. Most observers predict this to continue, but these big trend moves usually happen with corrections along the way. If the dollar does get much stronger it is a problem for Emerging Markets, particularly Asia and Latin America who depend so much on USD funding and/or have their currencies linked to the dollar. This would be compounded by trade tariffs if they materialise (Less trade and lower profits while loans have to be repaid in a stronger dollar). The Bank for International Settlements point to $10 trillion in USD denominated debt outside the United States.
Sterling will be driven largely by the on-going Brexit debate. GBP lost more than 20% vs. EUR from the start of 2016 (0.74) to it’s low around 0.90 in Oct/Nov – a truly enormous move. The pound has found a little respite since, strengthening to 0.84 as of mid-December. I am not going to attempt predicting where it goes next. Whatever any ‘expert’ tells you, accurately forecasting currencies is close to impossible, particularly with Brexit uncertainty in the mix.
Bottom line, If you are a business trading with the UK you need to pay a lot of attention to hedging your currency cash flows. EURGBP is going to be very volatile. If you are an investor, make sure you are diversified and avoid too much of a home bias.
Talk of a bubble in the Irish office market seems a little premature. Listed Irish real estate funds have had a rough run, accelerating lower post US election on expectations of lower demand from US companies. Some of these funds now trade at significant discounts to net-asset-value (c15%) and are not priced for any potential demand that might come from Brexit inspired relocations from London to Dublin.
The residential rental crisis and lack of new homes, partly driving (3) above, will hopefully see some respite in 2017 as new supply slowly comes on stream. However the number of units due for completion is still way below demand, so the path of least resistance for house prices is still higher.
Gold had a ripping start to the year, higher again on Brexit but then lower post US election. In EUR terms Gold strengthened more than 20% from January to July before trending lower, standing at +8% for the year at the time of writing. Gold performs a good job as a portfolio diversifier and insurance you can sell any time. It doesn’t yield anything, but neither does cash at this point in time. Is the post Trump selloff a great opportunity to selectively add?
Lastly, if like me you leave your Christmas gift buying to the last minute (!) here are a few suggestions from books & music released in 2016 that I enjoyed a lot.
My favourite reads of 2016 (in no particular order):
Jim Rickards “The New Case for Gold”
Pippa Malmgren “Signals”
Gideon Rachman “Easternisation”
John Kay “Other Peoples Money”
Jared Dillian “All the Evil of the World”
Willen Middlekoop “The Big Reset (Revised Edition)”
My favourite music of 2016 (again in no particular order):
Sasha “Late Night Tales”
Olafur Arnolds “Late Night Tales”
Grimes “Art Angels”
Jack White “Acoustic Recordings”
All Tvvins “IIVV”
El Vy “Return to the Moon”
David Bowie “Blackstar”
I would like to wish everyone a peaceful, relaxing and very Merry Christmas and best wishes for a successful 2017.
Ardbrack Financial Ltd | 021-4773833 | email@example.com | www.ardbrack.com
Disclaimer: The content of this article is for general information purposes only. It does not constitute investment advice as it does not take into account the investment objectives, knowledge and experience or financial situation of any particular person or persons. You are advised to obtain professional advice suitable to your own individual circumstances. Ardbrack Financial Limited makes no representations as to the accuracy, validity or completeness of the information contained herein and will not be held liable for any errors or omissions.
Ardbrack Financial Ltd is regulated by the Central Bank of Ireland