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Fresh ruptures

10 January 2017

In a year of political twists and stock market surges, it was the fourth quarter that stole the show, reports CIO Chris Ralph.

A year of surprises reached its climax in the final quarter, as Donald Trump beat overwhelming odds to win the US presidential election, an outcome that quickly made itself felt on markets both in the US and around the world.

The S&P 500 enjoyed its strongest year since the global financial crisis, and the final quarter was especially strong. Together with other leading US indices, the index struck several all-time highs in the final weeks of the year.

The ‘Trump rally’ that followed the presidential election appeared to float all boats, but certain sectors enjoyed a particular boost. US financials listed on the S&P 500 rose 20% over the course of the year, accounting for around half of the index’s gains1, and were helped in great part by the president-elect’s promise to deregulate the financial sector. Meanwhile, promises to deregulate energy drilling and to launch a large-scale infrastructure investment programme raised stock prices in the energy and construction sectors.

More broadly, Trump’s plans to cut both income and corporation taxes also buoyed sentiment. Conversely, his promises of protectionism appeared to have made no significant dent in the share prices of companies that could be adversely affected, such as the Californian tech giants, which rely heavily on immigrant employees – the tech-heavy NASDAQ index rose in the final weeks of the year.

Perhaps concluding that protectionist rhetoric could prove to be little more than campaign trail bluster, market participants’ fears were instead focused on debt and inflation. The yield on the 10-year Treasury had dipped slightly over the course of the year by the time of the election, but after Trump’s victory it rose from below 1.8% to finish the year at almost 2.5%2. The spike reflected fears that the president-elect’s combination of tax cuts and infrastructure spending would undermine the fiscal balance, as well as adding to inflation.

Interest rates were a major focus for markets throughout the year, especially given the extraordinary move taken by several leading central banks to push rates into negative territory – at year-end, headline rates remained at zero or in negative territory in, among other currency areas, the eurozone, Japan, Switzerland, Denmark and Sweden.

Having promised several rate rises in 2016, the US Federal Reserve, in an echo of 2015, waited until December to make its only rate rise of the year. By the fourth quarter, it had good reasons to do so: improving economic growth, an unemployment rate of 4.7%3, and a corporate earnings recovery. US inflation ended the year at 1.7%, close to the 2% target ceiling.3

The improving health of the US economy and the election of Donald Trump had major implications on global markets, especially through the conduit of a strong dollar. The UK enjoyed strong economic growth in the third quarter and witnessed a significant stock rally in the wake of the Brexit vote, courtesy of a falling pound. Over the course of the year, sterling dipped by almost a fifth against the greenback2, providing a boost to UK-listed multinationals, and even to some domestically-focused companies. The FTSE 100 rose 14.4% over the course of 2016 to end at an all-time high, helped by a falling pound and rising oil price – a barrel of Brent crude ended the year significantly above $50, thanks in part to a December deal between OPEC and Russia to cut production.

Inflation in the UK rose by 1.2% but the Bank of England offered no changes in the final quarter, saying it was willing to see inflation above the usual 2% target, if it helped growth and jobs.

In Japan and the eurozone, a rising dollar provided strong support for equities, and both currency areas enjoyed their strongest quarter at the end of the year – the FTSEurofirst 300 rose almost 6% and the Nikkei 225 by more than 16%. For sterling investors with holdings in these markets (and in the US), the returns were better still.

Yet the eurozone suffered a blow in December in the form of an Italian referendum in which voters rejected the government’s reform agenda, precipitating the resignation of the prime minister and ultimately forcing Rome to organise a state-led bailout of its most troubled bank, Monte dei Paschi di Siena. Banking and politics will remain challenges in the year ahead for the EU, as the UK triggers its exit clause; as Dutch, French and German voters go to the polls; and as other troubled Italian banks face their own funding deadlines.

Nevertheless, the obstinacy of the recovery in earnings, employment and the economy in the US, coupled with the strong performance of stock markets, suggests that there is much to look forward to, even as central banks slowly remove their support.

 

FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE's express written consent.

1 https://www.morningstar.com/news/dow-jones/retail/TDJNDN_2017010310454/earnings-not-donald-trump-are-stocks-best-friend-in-2017.print.html
2 Bloomberg, accessed 5 January 2017
3 Bureau of Labor Statistics, accessed 10 January 2017

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