The fourth quarter of 2016 was an eventful quarter, with notable developments being the Trump’s surprise victory in the presidential election, resignation of Prime Minister Matteo Renzi post Italian referendum, December rate hike by the Fed and ECB’s decision to further extend its quantitative easing programme until December 2017. These developments have led to turbulences across equity and bond markets. As we kick start 2017, investors may be fine tuning and preparing their portfolios for what seems to be an eventful year ahead as well. In this Idea Of The Week, the iFAST Research Team addresses 3 burning questions that investors have frequently asked in the recent times.
Q: Is the dollar strength sustainable?
A: The key question today is whether the dollar bull market is sustainable. While it is incredibly difficult to forecast currencies movements, expectations for loosening fiscal policy and tighter money do argue in favour for a stronger USD ahead. President-elect Trump has promised to streamline the corporate tax rate and spend on building up infrastructure. This has led to a view that US economy will strengthen further and a pick up in inflation. As a result, the Fed will require to hike rates faster than before. However, despite strong tailwinds for US dollar, we advise investors to be wary of chasing the fastest rising currency, given how much it has already risen.
Q: Given that those policies proposed by Trump are deemed to be negative for the emerging economies, is emerging markets still a buy following Trump’s victory in the US presidential election?
A: While scepticism is still hanging over emerging markets amid expectation of a stronger dollar and steeper US rate hike trajectory ahead, we remain our bullish call for emerging market equities. In reality, we have seen significant fundamental improvements for the region. Stabilization in commodity prices should contribute positively to terms of trades of emerging markets and hence healthier shape of current account ahead. In fact, current account for emerging markets has improved sharply since 2013 and this should serve as a strong mitigating factor for a strengthening US dollar and higher financing cost in hard currency. GDP growth in emerging markets has turned the corner and is accelerating, leading to a positive revision of earnings projections in the recent months. This coupled with its fair valuation should be supportive for emerging markets equities in 2017. While we recognize that significant changes to trade agreements are downside risks for emerging economies, we see positive catalysts outweighing those negatives for now.
Q: With the prices of commodities gradually normalizing, will it be a good timing for investors to have exposure to related sectors such as materials, energy and natural resources?
It is obvious that the past few years have been challenging for commodity-based equities. Significant falls in the commodities prices have caused a lot of pain. As a result, companies have been lowering its debt level and cutting down costs, which lead to healthier balance sheets and leaner cost structures nowadays. This coupled with bottoming commodity prices mean that materials, energy and natural resources equities are expected to strong earnings growth ahead, albeit coming from a fairly low base. After multiple years of valuation de-rating, the prospect for a valuation re-rating is finally in sight. Strong earnings growth and valuation re-rating should drive a rebound in equity prices in this segment. Optimism aside, there are still downside risks to our expectation. US dollar movements, which tend to display an inverse correlation with commodity prices may put a cap on how far commodity prices can rise given the recent episode of USD strength. In addition, rising prospects of trade protectionism, if materializes, could weigh on global growth which in turn would dampen demand for commodities. In short, the worst for this segment could be over and is a good time to re-look this segment. Neutral positioning is still warranted for now given the segment is still exposed to numerous downside risks for now.