This year, the US takes the lead in world economic growth, write Stewart Brentnall and Mark Rider.
We expect low double-digit earnings growth in 2017 to drive modest returns on investments as recovery continues across major economic regions.
How the developed world’s central banks increase interest rates, particularly in the US, will be a determining factor in financial markets this year.
Overall, we consider the outlook for stronger growth and inflation continues to favour shares over bonds.
It is stronger economic growth and inflation that will support growth assets this year, and this is the presumption markets are already making. So keep in mind that the price of shares now reflects the growth scenario for major economies outlined below. If there are downside surprises in US policy that disrupt global trade, this would cancel out the current growth-supporting initiatives that have been priced into sharemarkets and sharemarkets could react badly.
Sharemarket valuations across most developed markets are now moderately expensive, the US in particular.
For our favourable view of shares and other growth assets to hold we need to see:
1. the US dollar's rise to level off
2. for financial conditions to remain 'easy'
3. for the US central bank to keep gradually raising the federal funds rate.
The outlook for European shares has improved supported by central bank easing and a lower exchange rate, which should continue in 2017. Japanese shares are stronger due to a weak yen, and at fair value. And in Australia, shares are moderately expensive. Earnings have recovered strongly primarily due to the brighter outlook for commodities, while other sectors continue to experience only moderate growth.
It’s only in emerging markets we can say shares look attractive, with prospects likely to improve across that region this year, noting the elevated risks US policy and currency pose.
Bonds and currencies
Bonds are expected to underperform as rising economic growth coincides with higher US bond yields which will be capped by still high debt levels, easy monetary policy and moderate inflation. We are more constructive on the outlook for Australian fixed income as we expect the RBA to keep rates on hold narrowing the spread between Australian and US 10-year bond yields. Possible tightening of monetary policy in Europe could see bond yields shoot up.
The outlook for currencies is particularly challenging. Traditionally the US dollar softens when the global outlook brightens, as currently is the case, as investors feel more confident. However, with political risk elevated in both the US and Europe it is possible that sentiment could turn negative relatively rapidly that would support the US dollar as a safe haven.
Expectations for economies
Two broad expectations we have for 2017 is that major economies should keep growing and that considerable risks exist.
The case for growth is more or less clear.
Financial conditions and policies of the world's major economies are well positioned to continue expanding this year. As developed economies keep growing, unemployment will likely drop and wages and inflation rise, but not dramatically so.
In our view there is little on the economic horizon to short-circuit the current recovery. After a couple of years running at 3.2 per cent growth we now expect growth to lift to 3.7 per cent.
We expect growth to be led by the United States. Economic growth has accelerated there in the second half of 2016 and has become more broadly based. We expect a gradual pickup in coming months given the economy is close to full employment and growth is above trend. Interest rates seem likely to keep gradually rising although the outlook for the US dollar is less clear.
Considerable risks exist for the US this year and in 2018. The presidency of Donald Trump is expected to result in modest stimulus to the US economy from next year, with more spending on infrastructure and the military, as well as tax cuts. The administration’s policies on trade and immigration, which are still being worked out, could pose sizeable risk. And as economic policies appear likely to fuel stronger growth and inflation, the US central bank may have to increase rates quicker over the next few years than the market currently expects.
Of the three major developed market economies, only the US is likely to have inflation around target this year, with Japan and the eurozone around 1 per cent.
Sources: ANZ Wealth, Bloomberg, Thomson Reuters Datastream
The outlook for the eurozone has improved over recent months. The European economy is now in its fourth year of recovery, but hurdles remain with large divergences between regions, political uncertainty as France and Germany go to elections and banks still under pressure to build more capital. The zone’s economy is expected to grow 1.7 per cent in 2017.
The area’s easy monetary policy should continue to supportive the economy as inflation remains low. A key risk area to watch is politics: elections in the Netherlands, France and Germany are coming up and right-wing parties in these nations have record support.
Compared to prior years the Japanese economy grew reasonably well in 2016 and we expect that to continue with 0.7 per cent growth this year. Despite the government’s continuing stimulus program, sustained problems remain in consumer spending and wage growth. Inflation is rising only gradually, which is a persistent issue in Japan. We expect inflation of 1 per cent in 2017 and monetary policy to remain stimulatory with a weaker yen supporting economic growth.
While Australia is also expected to maintain growth, the price of our bulk commodities should ease from the 2016 surge but remain well above 2015 lows, just as we expect residential construction to also ease. And with higher interest rates in the US, our funding costs will likely rise. These three factors will pose some challenge to the domestic economy in 2017.
That said, non-mining business investment will increase, particularly in major east coast markets. And consumer spending should maintain healthy growth. Exports will strengthen the economy with increased demand for our services and liquefied natural gas.
Wage growth will continue at its lowly level and inflation will persist below the central bank target of 2 per cent to 3 per cent. The Reserve Bank of Australia is likely to keep the official cash rate at 1.5 per cent.
Sources: Thomson Reuters Datastream, ANZ Wealth, Bloomberg
China and emerging markets
We expect the outlook for the emerging economies to improve as global growth and commodity prices lift. However, while Chinese growth will likely consolidate we expect the economy will continue to face problems in restructuring its economy away from exports to domestic consumption.
A growth rate of 4.75 per cent is estimated across this region, as China slows and Russia and Brazil emerge from recession.
They could also be challenged by more protectionst trade policy from the United States, with such markets as China and Mexico particular targets. And while the outlook for the US dollar remains unclear, emerging markets would struggle if the greenback was to move sharply higher as many of these economies have their debt denominated in US dollars.
Despite this, China, the biggest of the emerging markets, is expected to stabilise its currency and capital outflow, though it won't be an easy job as its economy slows. Gross domestic product should rise by 6.5 per cent this year as the Sino services sector expands amid sluggish manufacturing and tepid investment.
Sources: Bloomberg, ANZ Wealth, Thomson Reuters Datastream