Biggest shocks of the past year are yet to play out

The UK’s vote to leave the EU rattled markets and sent the value of the pound plummeting. Triggering Article 50 has been scheduled by prime minister Theresa May for the end of March 2017. This will leave just two years in which to negotiate a deal for Britain outside of the union. Meanwhile, Mr Trump will be inaugurated on January 20, heralding a new era for US politics and, potentially, for its relationship with the rest of the world.

Salman Ahmed, chief investment strategist at Lombard Odier Investment Managers, observes: “The Brexit and Trump victories show that popular discontent is starting to shape political, and by extension, economic outcomes in advanced economies.”

These victories by so-called populist movements threaten to spill over into other parts of Europe, which is preparing itself for a wave of elections in 2017 – the results of which investors will watch closely.

If the rejection of globalisation continues to spread across Europe there will be profound implications, not least for the region's fragile banking systemMark Burgess, Columbia Threadneedle

Mr Ahmed explains: “The EU’s political calendar is very full over the next 12 to 18 months, with Austrian and French presidential votes, and general or federal elections scheduled in the Netherlands and Germany. These are being held against a backdrop of a rise in support for extreme right/left parties, and there is now a sizeable risk of a populist government coming to power that will put membership of the EU on the table. Almost all populist parties we monitor in various European countries have anti-EU, or at least anti-euro, agendas.”

The rise of such agendas would also have an impact on Europe’s already weak banking sector, as Columbia Threadneedle Investments’ global head of equities Mark Burgess states: “If the rejection of globalisation continues to spread across Europe there will be profound implications, not least for the region’s fragile banking system. Were we to see a further destabilisation of the eurozone brought about by populist parties looking to take a significant member state out of the single currency, that would place a lot of pressure on the financial system and impact significantly on global markets.”

As central banks reach the limits of their monetary policy capabilities, the expectation is that fiscal policy will play a much larger role in stimulating economic growth in many countries. 

John Husselbee, head of multi-asset at Liontrust, believes populism and the shift to fiscal stimulus are the reasons behind the recent rise in inflation expectations and bond yields.

He adds: “In recent years, synchronisation between asset classes internationally has been rising, a result of global efforts to stage a recovery from the 2008 global financial crisis. Quantitative easing has driven valuations up, defying the traditional negative correlation between equities and bonds. Monetary policy may now be falling out of favour, but fiscal stimulus is back in vogue, underpinned in the UK and US by infrastructure projects.”

Invesco Perpetual’s chief economist John Greenwood acknowledges it has become fashionable to talk about the end of quantitative easing, but says: “The truth is that, in the US, quantitative easing has actually worked well because it has been done correctly; it has also worked well in the UK. In both countries, economic growth recovered to about 2-2.5 per cent. In Japan and the eurozone, because of the way quantitative easing has been conducted, it hasn’t [worked as well]. If they had done it correctly, then the fiscal stimulus would not be necessary.”

With 2017 set to bring another set of political and economic challenges, investors may have to contend with a barrage of market noise and ongoing global headwinds as they try to retain conviction in their investments.

Ellie Duncan is deputy features editor at Investment Adviser