Merrill's 2017 Global Outlook
Here is the word from my breakfast with Bank of America-Merrill Lynch on the outlook for 2017. Global equities head Ethan Harris summarized the positives and risks of the new US government “good Trump, bad Trump” which contained no surprises although he certainly was right to call the election “a game changer.
He then moved on to a global tour which featured better ideas that Wall Street, notably Japan which of course has been the loser for decades. Now, citing house exert Louis Duvalier, Harris said “the stars are aligned” for growth: thanks “easing monetary policy” and “job market tightness”. He said in Japan it is now “all systems go”. Mr Harris also predicted that US wages will rise as pay goes into catch-up mode in the coming mature stage of the business cycle. Whatever Trump does, there will be higher inflation and higher interest rates in the US which will make financial assets less desirable than real assets next year..
US equities, they argue, have gotten ahead of themselves since the global financial crisis, having produced a12000 percent return since 1950, 65% of it since 2008 whereas non-US equities gained only 700% from 1950 and only booked half of this since the GFC. Chief economist Michael Hartnett then explained that “only if productivity picks up can you have your cake and eat it” getting growth without interest rates going up enough to nip it in the bud.
For the global economy, Mr Harnett predicted that there would be positive total return on markets next year but that “under the surface there will be tremendous volatility” as a result of exchange rate changes. He forecast that the yen will fall to 120 to the dollar and that the euro will fall to $1.05—but with lots of feints and reversals.
Mr Hartnett cited the biggest event (from his perspective) in 2016 was the day in July when the US 30-yr bond yielded 2.88% while the Swiss could borrow for 50 years paying a negative yield. “Everyone was positioned for that to continue” but of course it didn't after the Bank of Japan changed its policy from tight to easy fiscal policy rather than monetary stimulus, and these huge interest rate gaps disappeared.
As a classic economist, Mr Hartnett thinks the interplay of interest rates and inflation will determine growth and corporate profits and the house Merrill line appears to be that the US will not be the big winner in 2017. Instead, apart from Japan, there is more upside in EU which he called his “contrarian play”. He cited the fact that the capitalization of Apple and Google together exceeded that of all European equities as a reason for there to be more European profit and stock rises.
But he also warned about “massive dispersion” in results over countries and over time creating “rotation and volatility”.
Apart from Europe and Japan, the BoA-Merrill insights included a taste for oil company investment, and a focus on value stocks and small caps vs growth stocks and big stocks. This allowed the team to mention that that the next year will be one where active management would prove more lucrative than passive—a word from our sponsors.
Among emerging markets, Merrill thinks China will slow down from 11% growth in GDP in 2008 to 6% nest year. India will do better, with 7.2% growth next year (l6.67% from its stock gains, and eaving out the impact of the currency withdrawal which came after the forecasts were made). Merrill also expects cyclical recovery in Latin Americato produce real returns, with Brazil achieving double-digit ones along with Turkey, Russia, and South Africa. The Thundering herd also expects decent but lower positive returns in Mexico and Colombia, Poland, Czech Republic and Hungary, and anachronistically, in Israel, which it insists on calling an emerging market..
The elephant in the room is China which is expected to continue to cheapen its currency against others—notably the US$. Merrill currency expert David Woo predicts that under Trump, “the US and China [will be] on a collision course in 2017”. While nowhere as bearish about the RMB than CLSA (which expects a 19% fall to 8 to the dollar) or Rabobank (which expects a 12% drop to 7.6 to the dollar), BofA calls for 7 RMB to the greenback, a drop of 4%, by the start of the new year, a level not seen since 2008. The consensus is that mounting debt and slower growth will zap the currency.
Overnight there was a scary episode which showed what this might mean when the Chinese renminbi fell sharply. It seemed like a deliberate devaluation to show Pres.-elect Trump who controls China's exchange rate policy. But in the end, it turned out to be a fat fingers goof perpetrated Monday night by a UK money brokerage, ICAP plc. Here again we dodged a bullet, as for some years we owned the ADR, IAPLY. But in fact the bullet dodged was by the whole world, because a deep renminbi devaluation could have caused a major international incident with the future US Administration, and a test of Trump's temper. Luckily it was just an error by markets.
I also may have given too much credit to the PEOTHUS over his telephone conversation with the Taiwanese president, in violation of taboos which date back to the Nixon-in-China deal. My assumption was that It turns out that a lobbyist for Taipei, former Senator Bob Dole, arranged the chit-chat over the course of 6 months for $150,000 in fees.
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