Without question, 2016 was the year of the big surprise. Or to be more accurate, surprises.
The biggest surprises were the Brexit decision in late June, when—despite all expectations to the contrary—the UK electorate voted to leave the EU, sending markets into a tailspin for a few days while pushing sterling lower. Then, just when markets appeared to have regained their footing, the US electorate provided the next, possibly even bigger curveball—the unexpected election of Donald Trump as 45th President of the United States.
Perhaps not a bombshell by the time it occurred, but nevertheless surprising in light of how long it took to play out, the Fed finally raised interest rates at the end of 2016, only the second time it hiked since 2006, after indicating at the end of 2015 that four hikes would probably occur in 2016.
It was an eventful year for markets from the outset. On January 4, the sharp selloff of the Shanghai Composite continued the meltdown that began in mid-2015. It was driven by fears of a slowdown of China’s economy and additional yuan devaluation. Though government intervention stanched the bloodletting, it’s been a roller coaster ride for Chinese markets throughout 2016.
Both the commodity and the benchmark index have recovered nicely. Currently crude is priced at around $53.00, while the Dow, having already reached a number of all-time highs over the course of the year, now sits just a hair below its next record—the hallmark 20,000 level.
Gold, which many assumed would be a major beneficiary of such risk events as Brexit, as investors and traders went in search of safe havens immediately after election results were announced, hit its 2016 high during July, $1,364. Many predicted a new bull market for the Precious Metals complex, but the baby bull faltered and as of this writing appears to have died….at least for now. Gold is currently trading at around $1,130, its lowest level in 11 months.
There were some serious surprises in FX markets as well. The U.S. dollar looked to be weakening as 2016 commenced, with the US Dollar Index hitting its 2016 low of 92.62 on May 2. But as events during the second half of the year played out, king dollar reasserted its strength; the DXY is currently hovering around 103.00, a level not seen since December 2002.
The GBP and EUR didn’t fare nearly as well. The pound is currently trading at 1.2277 vs the USD, not far from a 31-year low of 1.2020 touched in the immediate aftermath of the Brexit vote. The euro is hovering at a 13-year low of $1.0456 though analysts predict there’s USD parity in its near future, possibly followed by a fall below that benchmark.
As we await the inauguration of the US’s next president, and markets continue to benefit, albeit perhaps less and less forcefully, from the Trump Bump, we asked 10 of our most popular contributors to tell us how they see markets performing as 2017 begins.
This installment covers Commodities and Currencies. Part 2, offers author calls on Stocks, Bonds and Inflation.
The price of oil should finally stabilize in 2017. OPEC, coming off its productive meeting at the end of November, is once again saying the right things and working towards cooperation to limit production and raise prices.
The OPEC production cuts may never be implemented fully and likely will not last for too long, and further hurdles remain to bringing the full range of non-OPEC producers on board, but the movement is now clearly in the direction of combined production limits.
The impact on Tehran of the soon to be inaugurated Trump administration should also be favorable for oil prices, with the possibility of renewed sanctions and the certainty of added unease for foreign firms considering investments in Iran. The messages coming out of OPEC and Russia alone, will create price spikes, while the actions should set a floor price of at least $55.
The Aramco IPO—coming either in late 2017 or in 2018—will be a success. Aramco is too well run and controls resources that are far too valuable for it to not succeed. However, investors will need to understand that the company will still be run by the Saudis and investors will only be along for the ride.
Renewed Life for Some Shale Producers
In the U.S., higher oil prices will bring renewed life to some shale producers. Changes in government policy, brought by a new and friendly Republican administration, will open opportunities for a myriad of energy-related investments and businesses.
Drilling on Federal land and offshore, especially along the Southeastern coastline, will be easier for small and large producers alike. Energy infrastructure projects, including pipelines, will see renewed possibilities as well. However, railroads as a transportation for oil will suffer if pipelines become preferred once again.
As was the case last year, a safe prediction is that:
“with continued low crude oil prices [below the 2014 highs of $112bbl], decreased global passion for climate change, and… a Republican administration in the White House, investors should be wary of renewable and clean technology in the long term.”
Even when oil prices stabilize, it will be a while before they reach the high double digits that precipitated such economic interest in alternative energies.
Moreover, the global mood is turning against climate change fear. President-elect Trump has stated multiple times that he supports “all” forms of energy, but investors should expect that any changes in the U.S. tax code will hurt alternative energy and electric car startups. The Department of Energy will likely alter or lessen its venture-capital-like behavior as well, providing less Federal assistance to alternative energy businesses.
Global and US Refinery Upgrades
For more risky opportunities, consider refining projects in both India and the U.S. While India is not likely to become the next China for energy consumption purposes, India is now the third largest energy consumer and will be particularly in need of enhanced refining capacity.
American refineries are also in need of an upgrade, particularly to handle the volume and type of shale oil produced. Before the U.S. is able to increase its refining capacity, however, look for U.S. oil exports to pick up in 2017.
In the coming year, the markets are likely to be dominated by geopolitical forces and stifled GDP growth which will have a myriad of consequences. Among the currencies likely to be most exposed to these forces will be the GBP, EUR, and AUD. As a result, the bears out there could be cruising for a year of sizable downside potential.
Starting with the GBP, the inescapable fallout of Brexit will still be felt next year, especially as the UK government navigates its disentanglement from the Eurozone. As a result of this, the policy responses from the Teresa May-led government will be in the headlights and news regarding the negotiations around Brexit and the role of the UK going forward could be as influential as Interest rates or even GDP results.
Moreover, given the current lean towards a “Hard Brexit” the outlook is looking fairly grim for the UK and, by extension, the GBP. The cost of a hard Brexit is forecasted at around £66bn per annum for the UK Treasury and could reduce long-term GDP growth in the UK by up to 9.5%.
EU Challenges Could Keep EUR Depressed
Looking across the channel, the EUR could be in for a no easier time than its UK counterpart. Whilst the effects of Brexit will be somewhat more muted on the continent, the EU faces challenges from within which could keep the EUR depressed in the coming year.
Specifically, the growing fears over the rise of Front National, in the wake of the apparent global swing towards hard-right populist leadership, will be central to the EUR’s health moving forward. This is due to Ms. Le Pen’s commitment to following the UK’s lead and exiting France from the EU, the result of which would likely be catastrophic for the Union.
Consequently, assuming we have learned our lesson from both the Brexit and Donald Trump, the market should be giving the EUR a wide birth as long as Ms. Le Pen has a shot at seizing power.
Australian Mining Boom No Longer Able to Prop Up Economy?
Finally, the antipodes will also be feeling the heat as the threat of recession looms over the Australian economy. Only recently having posted a contractionary quarterly GDP result of -0.5%, speculation is already rife that the nation’s mining boom is no longer able to prop up the economy.
Such fears are hardly surprising, especially given dwindling CAPEX and investment over the last 12 consecutive quarters. As a result of the impending downturn, expectations of stimulative interest rate cuts in the New Year will be surging which will likely put the Aussie dollar under some significant pressure. What’s more, the effect of these cuts will spill over to the country’s Pacific neighbour, New Zealand, and force them to follow suit and devalue the NZD in the process.
Our proprietary market barometer looks at all leading markets, and gives a sense of intermarket dynamics. The point in this is that markets do not move in a vacuum, they move in relation to each other.
Right now, risk assets are in a bullish mode: stocks, yields, copper and crude are all in a long term uptrend. On the other hand, gold and the Japanese yen, both fear assets, are in a long term downtrend.
The market barometer reflects the state of markets at a given point in time. To get a sense of what the future will bring, we look at our leading indicator: 20-year Treasury yields. The chart below makes the point that 20-year yields introduce a new phase in markets (risk-on vs risk-off) exactly at times when extreme high or low fear levels coincide with peaks and bottoms on its long term chart (see red and green circles on the chart).
Right after the Brexit vote, 20-year yields bottomed. For many it was a time of maximum fear. That was a turning point for risk. Since then, risk assets started outperforming fear assets. Stock markets broke to all-time highs, copper and crude rallied, while gold sold off.
Risk-on Through First Part of 2017
With our leading indicator suggesting risk is on, we expect this trend to continue into the first part of 2017. As of the summer, our expectation is that stock markets will start correcting, potentially very sharply. Bonds will become attractive at that point, in line with our former bond market outlook, while commodities will certainly not be attractive.
When it comes to gold, it is too hard to make a prediction. If gold continues to behave as a fear asset, we expect gold to head into a long-term uptrend. The challenge with gold is that it has two faces. On the one hand, it is a fear asset. On the other hand, it is an inflation/deflation driven asset. Gold’s prospects always need to be assessed in the context of what other markets are doing.
Initially, our gold price forecast remains bearish. We will need to re-evaluate towards the summer of 2017, and make a new call based on inter-market dynamics.
Undoubtedly, 2016 will forever be remembered as the year of the "populist ballot box revolt." From Brexit to Trump to Italy's constitutional referendum, the masses made their distaste with the status quo establishment heard through the ballot box, regardless of the consequences.
The reverberations from these decisions will no doubt be felt for years and decades to come; but the biggest takeaway for 2017 may be that "political risk" is still on the rise, especially in Europe.
The coming year will bring a presidential election in France, where the far-right National Front party has been gaining ground of late, as well as national elections in Germany and the Netherlands. These represent three of the largest and most important economies in Europe, and depending on how these votes go, political uncertainty could throw the region back into recession in 2017.
Meanwhile, the US economy and dollar are poised for a strong year. President-elect Trump will be eager to improve his approval rating and follow through on campaign promises by unleashing a massive wave of fiscal stimulus (tax cuts and infrastructure spending). The long-awaited government contribution to GDP will juice economic growth and inflation in the short term, finally allowing the Federal Reserve to "normalize" interest rates at a more aggressive rates.
While the long-term ramifications of such a strategy remain to be seen, the expected economic divergence between Europe and the US should finally drive EUR/USD below parity (1.00), three years after strategists first started calling for such a move.
There is a Benjamin Graham quote that is often misquoted in which he was supposed to have declared that in the short term the market is a 'voting machine', but long term it is a 'weighing machine'. But what he actually wrote in 1934 in his book Security Analysis was this:
'..the market is not a weighing machine....Rather we should say the market is a voting machine, whereon countless individuals register choices which are partly the product of reason and partly the product of emotion....Hence the prices of common stocks are not carefully thought out computations, but the resultant of a welter of human reactions......'
That's a particularly apposite quote in the aftermath of the US Presidential election, as traders and investors now face major shifts in both monetary and fiscal policy, not only in the US but in all the major economies. And our mantra for 2017 should be 'expect the unexpected', something many financial experts, commentators and pollsters singularly failed to do in 2016!
US Markets Continue to Defy Expectations
Thus far it has been US equity markets that have continued to defy commentators and analysts with November's volatility simply viewed as an opportunity to push the benchmark indices into new high ground. Indeed the lack of any meaningful correction in equity markets has been the concern of many in 2016, particularly when the average number of days before a 20% correction is usually 635 days.
The present market is overdue by more than three times this average. But the key here is not whether the indices will continue this record breaking run, but which sectors are likely to flourish in the new monetary and fiscal environment.
President-elect Trump has already outlined some of his priorities, namely major infrastructure spending, which has already resulted in stocks such as Caterpillar (NYSE:CAT) moving sharply higher. Other sectors to watch will be health care and pharmaceuticals, particularly if there is a major restructuring or abandonment of Obamacare.
Underpinning this shift will be a normalization of interest rates, and a consequent rise in inflation, two factors that have always favoured the financial sector and gold.
US Dollar Impact
For the US dollar the Trump win was the catalyst for the breakaway from the long consolidation phase on the DXY, with the break of the March 2015 high of 101.38 taking the index to 102.12 in the days following the election. From a technical perspective the upside levels to watch on the DXY are 102.82 of August 1998 and 106.52 of June 1989.
Any break through these levels would clear the way for a re-test of the 2001 and 2002 highs of 121.29 and 120.80 respectively. The prospect of a surge in the USD in 2017 has many implications, not least for emerging markets where the prospect of having to service more than 3 trillion in dollar-denominated debt has the potential to destabilize the entire global economy.
The impact of a surging dollar in the currency markets, in particular against the euro, will also coincide with the single currency once again facing further threats to its very existence as well as the prospect of moving to parity, and lower still. If we start with the technical picture, the key price region for 2017 is 1.0450 to 1.0500, an area that was tested on several occasions in 2016.
Nevertheless this has so far held firm, and has been providing a strong platform of support since 2015. However,if a move to parity is almost certain, with the potential to move down to the 0.9450, a price region last seen in mid 2002.
Fundamental and Political Pressures on Euro
From a fundamental and political perspective the pressures on the euro are many and varied. First, we have the ongoing bailout drama in Greece which has continued to fester in the background, but still has the potential to erupt at any time causing the single currency—and the markets—further volatility and uncertainty.
To this we must now add the situation in Italy where a banking crisis in which bad loans at Italy's third largest lender, Monte dei Paschi di Siena (MI:BMPS), a bank founded in the 15th century, is threatening to spill over and contaminate the wider European banking system. In addition the political landscape in Italy is far from stable following November's referendum, and any failure to establish a new Government will inevitably lead to fresh elections in which eurosceptic parties are projected to gain a significant share of the votes.
These parties have made no secret of the fact that, if granted the opportunity, they will call for a referendum on Italy's continuing participation in the euro project. However, this will not be a replay of Brexit, as most Italians are still in favour of the eurozone.
Elections Across Eurozone Could Bring Further Euro Angst
If Italy does manage to avoid an election, elections in Holland, France and Germany in March, May and October respectively, all have the potential to cause the euro, and eurozone further angst, and even call into question its very existence. The Dutch election will be interesting as it will be the first opportunity to gauge the extent to which eurosceptic rhetoric translates into votes and power. However, it is the French election in May which is potentially the most explosive given France's role as a founder member of the what was originally known as the Common Market.
For France, next year will be a test of whether Marine Le Pen's National Front (FN) party can take power and offer the French a referendum on membership of the EU. However, unlike the UK France has a written constitution that binds it to the European Union and which theoretically precludes it from any easy exit.
The key here will be the level of support for the National Front, and whether this will be sufficient to instigate any constitutional changes to offer the French electorate this choice. And unlike previous euro crisis, this would indeed herald the demise of the euro project in its current iteration. In short, 2017 could be the year that decides Europe's and the euro's fate.
Oil: Cocktail of Politics, Posturing and Play Acting
For oil, 2017 will be another cocktail of politics, posturing and play acting. On the one hand we have OPEC balancing the demands of its member states, controlling supply from non members whilst simultaneously involved in a price war with the alternative suppliers.
This is a novel experience for OPEC who are now the 'jam in the sandwich' and under pressure from all sides. Tighten supply too much, and prices are likely to rise further, thereby encouraging the alternative suppliers.
A loosening of supply will see prices fall, but increase pressure from members and non member alike with the prospect of tentative agreements now in place with Russia and other producers fracturing. From a technical perspective the recent agreements have seen oil prices spike higher, and up to test the highs of 2016 in the $55.50 per barrel price region.
This is now a key level of potential resistance, and with volumes now building on both the weekly and monthly charts and with a sustained congestion phase now underpinning the price action we could see oil prices continue higher to test the $62 per barrel area early in 2017. Longer term we may even see a return to the $72.00 per barrel region of 2015.
Gold May Finally Shine Again
And finally to gold, which in the light of increasing interest rates, inflation, banking crisis and existential threat to the euro may finally shine once again. However, from a technical perspective the precious metal still looks bearish on the monthly chart. The key levels now in play are those at $1120 per ounce, and if this is taken out potential support awaits at $1050 per ounce.
If this is breached, then a move below $1000 per ounce looks increasingly likely. To the upside, strong resistance has been building over the past two years in the $1360 region. With volumes rising in a falling market on the monthly time frame this level looks unlikely to be tested.
In summary, whilst 2017 promises to deliver fresh levels uncertainty and volatility it will also offer plenty of trading opportunities—provided we understand the continuing interplay between politics and economics.
Editor's Note: Read Part 2: Market Outlook 2017: Stocks, Bonds Inflation and SPX 2400.
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