The health of the global economy continues to depend on the fortunes of the US, the eurozone and China, says Lazard Asset Management’s Ron Temple.
Each of the world’s three main economies is at a different stage of the economic cycle and faces different challenges.
In the United States, President-elect Trump is inheriting quite a good story in spite of the campaign rhetoric.
The foundation for economic growth continued broadening in 2016, with the middle class finally participating more fully in the recovery.
The most likely result of Trump’s election is corporate tax reform with provisions to encourage the repatriation of overseas earnings.
However, markets largely have ignored the increased uncertainty that Trump presents given the lack of a clear policy agenda.
Our base case expectation for the United States is that growth rates will accelerate by roughly 20 basis points (bps) over the period from 2017 to 2018, assuming lower corporate tax rates and a sizable infrastructure investment program will begin to be implemented later in the year.
Importantly, while inflation and inflation expectations bottomed in the first quarter of 2016 and will continue to grind higher, we do not expect a spike in inflation anytime in the next one to two years.
The eurozone economy has gradually improved since 2013. Inflation remains low, but deflation fears have subsided somewhat.
In 2017, our base case expectation for the eurozone is real GDP growth of around 1.5 per cent, with sustained low inflation.
We expect the European Central Bank (ECB) to continue its easy money policies with negative interest rates and large purchases of government bonds as announced on 8 December.
The divergence between ECB and Fed monetary policy will likely weaken the euro against the US dollar. Recent growth in the euro zone economy has brought real GDP above pre-crisis levels, but outcomes have diverged significantly between individual countries and domestic demand remains weak.
Political risks will continue to rattle markets through 2017. UK Prime Minister Theresa May has indicated that she will invoke Article 50 to begin the process of leaving the EU in the first quarter of 2017.
There is also a busy electoral calendar in 2017. The French election is the most worrisome, as there is a meaningful chance that the National Front, a nationalist political party, could win the election on an anti-euro, anti-EU, and anti-immigration platform.
From an economic perspective, China was an upside surprise in 2016 as the government boosted spending meaningfully and as credit flowed freely into the domestic economy.
However, easy credit inflated fears of a housing bubble across the largest cities leading to incremental measures to clamp down on borrowing and speculation.
As the year wound down, the Chinese renminbi depreciated further, increasing the pressure on the capital account as Chinese companies and residents tried to move capital outside of the country.
Looking forward, we expect growth to decelerate further in 2017 and the renminbi to continue to weaken against the US dollar despite ongoing intervention by the Chinese authorities.
We also expect to see the transition from an export-oriented industrial economy to a more middle-income service economy sustained.
One key wildcard in this outlook is how potential protectionist policies from the new administration in the United States could affect China’s trade response and ultimately growth.
In 2016, we acknowledged that equities were not cheap relative to history, but were still attractive relative to fixed income, in our view.
We also noted that the ongoing quantitative easing from central banks globally was likely to continue driving equity prices higher.
This has played out and we still see room for upside. The basis for our positive view of equities, however, has changed.
In the United States we are more focused on the prospects for what could be a sweeping reduction in corporate tax rates and a tax reduction on earnings repatriated from overseas.
Outside of the United States, valuations are more attractive, but these markets lack the potential incremental catalyst of major tax rate reductions.
Nevertheless, we remain positive on global equities even though they are expensive relative to history, given their better value compared to fixed income.
It will be critical to focus on company-specific implications of policy changes and ensure that winners are separated from losers in both equity and debt markets.
We are generally optimistic in terms of the growth outlook for 2017 and now believe growth could be slightly stronger than we expected before the US election.
We see a positive environment for equities, barring unforeseen geopolitical and policy shocks, on the back of potentially positive tax policy changes and low global interest rates.
Ron Temple is a portfolio manager and analyst at Lazard Asset Management.