Before looking ahead, let's first take a look at what happened in 2016. There is still no solution to the Syrian conflict and ISISproblem, the threat of Russia's and China's foreign policy ambitions is growing, and populism is on the rise in Europe. We also had the Brexitvote and Donald Trump's election win. In light of these events, you could say that markets held up fairly well. Does this mean political stock markets are essentially short-lived and that investors should turn their attention elsewhere? Hasn't it always been said that markets loathe uncertainty? The outcome of the Brexit process is still open, and it may take several months before we know which political agenda can and will be implemented in the United States. Not much proof of this uncertainty can be seen on the markets thus far, particularly on the U.S. stock markets.
On the contrary, U.S. markets are trading at record levels. Investors have been showering Trump with premature praise, expecting him to be a game changer. In this type of environment, investors can't afford to forego a political analysis. Especially when it comes to the United States, whose currency, interest rates and stock markets set the pace for the rest of the world. Investors need to make sure they have a clear idea of some aspects such as who decides, when do they decide and with or against whom, and who has veto power? Where are the monetary and fiscal boundaries, and which international ties should be considered? Those with a clear idea in the case of the Brexit vote and the U.S. election were and are already well ahead of most politicians and market players.
For the time being, however, markets are playing the "higher growth with a controllable rise in inflation" scenario. We also expect to see the kind of positive momentum that can be sparked by hopes of a stimulus package. At best, this euphoria takes on a dynamic all of its own and is reflected in economic data even before government measures take hold. If not, then U.S. markets are presently setting themselves up for a great potential disappointment. Should the new administration take longer than anticipated to accept the realities of governing, the market's enthusiasm may come to an abrupt end. The reverse is taking place on Europe's stock markets. These markets price in political risk, demonstrated by their valuation gap relative to the United States. Given the promising signs coming out of countries such as Spain, and even France where reformer Francois Fillon has won the conservative primaries, the potential for positive surprises could indeed lie in Europe. Nevertheless, we have chosen to enter the new year without any strong regional preferences. This decision, as well as all of our positions, will be reviewed regularly in view of U.S. political developments. We are keeping a close eye on the positive and negative surprise potential brought on by the coming U.S. President. After all, politics moves markets.
Stefan Kreuzkamp, Chief Investment Officer