Looking back over 2016, some might say that investment returns for most asset classes have been very good, particularly in sterling terms.
But it is the explanation put forward for these returns that will be the most difficult aspect of understanding the year.
A sober assessment of returns normally cites a better-than-expected earnings growth backdrop, or perhaps an unanticipated pick-up in economic activity. However, 2016’s returns have been achieved with only reasonable economic and modest earnings growth. So the most obvious candidate for the surprising returns appears to be politics.
The vote to leave the EU set off a surprisingly strong market in both bonds and equities. This was followed up with the surprise of Donald Trump winning the US election, which has proved to be less good for bonds but helped the major US equity indices to all-time highs. This differentiated performance between bonds and equities may be due to the pre-election inflationary signs observed in the economic data being enhanced by Mr Trump’s policy pronouncements, which in aggregate are pro-growth, but also inflationary.
So, what next? Markets are getting to grips with the pick-up in inflation data and choosing to give a lot of credit to Mr Trump’s policies that will not be enacted for some time. Arguably this rally needs another story to support it. The theme for 2016 seems to be political surprise, so perhaps this is what we should be seeking out. The most obvious candidates for this appear to be Italy and Austria with votes on December 4.
In Italy, Matteo Renzi has proposed reforms that appear to help the country in its desire to become more efficient, but he experienced a ‘Cameron-esque’ moment and gave the Italian people a referendum to decide on the reforms, offering to step down if necessary. The Italians appear willing to issue a protest vote and Mr Renzi is on shaky ground with less than 30 per cent support. This might be viewed as a threat to the European project and, as such, may weaken the rally in risk assets, certainly in Europe.
The Austrian election may offer us a view as to the rise of right wing politics across Europe – again with consequences for Europe and immigration. The candidate for the Austrian Freedom Party, Norbert Hofer, narrowly lost the election in May, but electoral improprieties meant the result was overturned and a re-run ordered. His major bugbears are Austria’s rising unemployment and immigration, with a strong suggestion that these will be difficult to tackle while in the EU. Again, this would not be viewed positively for European equities, but recent history tells us not to make such bold assumptions.
Next year sees further political intrigue in Europe, with the Netherlands, France and Germany all going to the polls. March sees a general election in the Netherlands, France shortly afterwards and then Germany in September. In all cases, anti-immigrant, pro-growth, nationalist polices appear to be more popular than would have been suggested a year ago.