One City commentator provided what may prove the pithiest and most accurate summary of the last 12 months: “2016 – not for the faint-hearted.”
Remarkably, he was speaking not at the end of the year but close to its beginning, when the big story was an apparently endless share price crash on the Shanghai stock market, and associated fears that the emerging market boom had very definitely gone bust.
By the time the festive season beckoned at the far end of the year, the “China crisis” was all but forgotten in an investment landscape that had seen a sequence of extraordinary events: the Brexit vote, the election of Donald Trump and the rejection of Italy’s prime minister Matteo Renzi in a referendum he had called on reforms to the country’s constitution.
Any one of these events may, in more normal times, have been expected to have investors stampeding for the exits. It is not every day that a top-five economy and a nuclear power decides to terminate a central feature of its foreign policy, or that America’s voters reject a seasoned political professional and send to the White House someone with absolutely no governing experience of any kind, or when a founder-member of the European Union – one whose banking system is riddled with bad debt – effectively sacks its prime minister by denying him the tools to press ahead with necessary reforms.
All the countries involved are members of the Group of Seven rich nations. Put all three seismic events together, add in a commodity price slide, savage warfare in the Middle East and nuclear tensions with a resurgent Russia, and surely a sharp decline or even collapse of asset values would be on the cards? Well, not so far.
Viewing bad news as good news
After initial falls, share prices rallied in all three jurisdictions. In the City and Wall Street they actually ended up higher than they had been – the FTSE 100, the Dow Jones index and the Standard & Poor’s 500 all topped their pre-event highs.
In Milan, the FTSE MIB did not return to the peaks seen at the start of the year but it still recovered strongly from the tumble it took in the immediate aftermath of the referendum.
The rationale was different in each of the three cases but underlying all of them was a paradox: bad news could be seen as good news.
In the British case, the June 23 vote to leave the European Union triggered a sharp fall in the value of the pound, from just shy of $1.50 on the eve of the vote to a low of $1.21 before recovering to $1.25 towards the end of the year. For firms listed on the outward-facing FTSE, more than 70% of whose revenues are earned outside the UK, sterling’s decline was a boon in that it made exports more competitive in overseas markets and inflated the value of foreign currency earnings when translated into (weaker) pounds.
Looking on the bright side
For the US, the “Trump bump” – the post-election rally in share prices – reflected a determination by investors to look on the bright side of Mr Trump’s policy positions. His advocacy of cuts in corporation tax and income tax went down well with businesses and finance, while his pledge to spend billions of dollars on infrastructure promises to do wonders for the profitability of construction and civil engineering companies. Likewise, his planned arms build-up would be good news for defence contractors.
Forgotten, for the time being at least, were fears that the president-elect’s numbers do not add up, that cutting taxes while increasing spending will simply mean an even larger deficit and that this, in turn, will put upward pressure on interest rates.
Markets were also seemingly turning a blind eye to Mr Trump’s hostility to free trade, in contrast with most in financial markets who embrace global commerce. He has said he will renegotiate the North American Free Trade Agreement linking the US, Canada and Mexico, a deal signed in 1994 by Hillary Clinton’s husband Bill during his presidency, and has already killed off the 12-nation Trans Pacific Partnership trade deal painstakingly stitched together by his predecessor, Barack Obama.
Prospects for the US-EU Transatlantic Trade and Investment Partnership look little brighter, given hostility not only from the Trump team but also from politicians, trade unions and others in Europe.
A silver lining was even found in terms of suggestions that Mr Trump’s policies could set off US inflation once again – given how far below the 2% target the rate, currently 1.6%, is standing, perhaps a spot of Trumpflation is just what the doctor ordered. It would at least underpin the move back towards more normal borrowing costs seen at the end of the year.
Reflecting the strengthening of the US economy, America's central bank, the Federal Reserve, moved on December 14 to raise interest rates for only the second time since 2006. The range for the key federal funds rate was hiked by a modest 0.25 percentage points from 0.25% to 0.5%, to 0.5% to 0.75%.
Mr Trump himself has criticised the ultra-loose policies of the Federal Reserve – a somewhat novel position for a politician, given they mostly demand an easier rather than harder monetary stance.
In Italy, Mr Renzi’s defeat was seen as likely to spur a clean-up of the banking system and possibly persuade the European Central Bank to instigate further economic stimulus measures.
Commodities and emerging markets
As the US president-elect assembled what seemed, generally, to be a reassuringly normal cabinet team, the 13-nation oil cartel the Organisation of Petroleum Exporting Countries (OPEC) surprised observers by agreeing a deal on November 30 to cap production in order to support the price.
This cheered markets, a large slice of whose capital value is represented by energy companies, and the crude price emerged from the doldrums. Brent, which opened the year at less than $40 a barrel, was trading at over $55 by mid-December.
Meanwhile, gloom about emerging markets was partly lifted by the stellar performance of India, whose economy fired on all cylinders as the reforming government of prime minister Narendra Modi swept away obstacles to growth, not least the cat’s cradle of sales taxes that were replaced by one goods and services tax, creating a single Indian market for the first time.
What of China, whose problems had looked set to be the big story of 2016? Here was the International Monetary Fund’s distinctly mixed view in October: “China’s growth rate – while declining – remains high, and the recovery is gaining traction elsewhere. A closer look, however, gives cause for disquiet. China’s growth stability owes much to macro-economic stimulus measures that slow needed adjustments in both its real economy and financial sector.”
It would be a brave person who bet against repeat Chinese turbulence early in the New Year. Perhaps 2017 will also prove not to be a year for the faint hearted.
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