Economic recovery continues across most of the eurozone bar Italy, which is dangerously close to falling back into another recession.
Region-wide, surveys of firms’ employment intentions have broken out after reaching a plateau at the start of the year, and this should support consumer spending growth as the boost to discretionary spending from lower energy prices wanes. The demand for credit continues to increase and broad money supply growth has steadied at an annual rate of around 4 per cent to 5 per cent over the last year
The global starting point is also encouraging. Our global leading economic indicator suggests there will be a strong first half of 2017.
Yet, despite all this positive context, there is much to be uncertain about in 2017. There is Donald Trump, Brexit, Italian banks and the price of commodities.
And then there is a string of elections in the eurozone where anti-EU tickets have a real chance of success, putting at risk the confidence investors have in an economy still being weaned on from life support.
The Dutch start us off in March, France goes to the polls in April and May, Italy may follow suit at some point if the newly formed interim government struggles to rule, and Germany will vote for a new government in September and October.
All of this has the potential to undermine economic confidence, making the spread of likely outcomes for the business cycle wider than usual. The risks posed to the global economy, while serious, are unlikely to result in recession in 2017, but they could quite easily undermine market confidence.
There is a strong correlation between the rate at which investors will discount tomorrow’s earnings into today’s price and the broader economic uncertainty.
In other words, as investors become less certain about the direction of the overarching business cycle, they will become less certain about future corporate cash flows, so demand a higher rate of return. It is surprising then that the rate at which investors are discounting earnings by has fallen sharply over the last two months in spite of what has happened in Washington and Rome.
More technically, the equity risk premium implied by current market levels has fallen to one of the lowest levels – or rather one of the most sanguine levels – we have observed over the last five years.
So while we recommend staying invested, a cautious approach seems warranted.
Across the Channel, investors will be bombarded with political events in 2017. Eurozone politics were fractious enough before you remember that the Italian banking crisis rolls on and inflation expectations remain worryingly weak.
The pro-eurozone Italian prime minister resigned in December, and the far-right, anti-eurozone Marine Le Pen is likely to win the first round of the French presidential elections in April. While we do not believe that either of these developments poses the existential threat to the eurozone that many commentators are making out, there is still much to mull over, so many investors may start to increase their discount rates.