After a turbulent second half in 2016, we enter a new year against an equally challenging political backdrop.
BETTER CYCLICAL OUTLOOK VERSUS POLITICAL HEADWINDS
The election of Mr Donald Trump as the new United States president and the Brexit vote marked the two biggest political shocks to markets in 2016, and both events will continue to have significant impact on financial markets in the next 12 months. A busy electoral calendar and policy uncertainties are expected to fuel continued volatility in the equity, bond and currency markets.
For 2017, we go west and east as we see the most attractive growth opportunities in the US and Asia.
For Asian investors seeking stable returns with controlled risk, we believe global diversification and a balanced portfolio will be crucial.
We expect a moderate improvement in global growth outlook in 2017 , driven by more expansionist fiscal policies in the US, continued stabilisation of China growth and recovery of the oil producers in emerging markets.
U.S. AND ASIA OFFER THE MOST ATTRACTIVE GROWTH OPPORTUNITIES
We take calculated risk in equities and credit to reflect a slightly improved global cyclical outlook, thus upgrading our equity view to neutral from underweight. However, we think a selective investment approach is necessary to mitigate lingering political uncertainties.
We continue to stay negative on European equities due to structural challenges and political headwinds in the euro zone.
Within our balanced global equity portfolios, we stay overweight in US and Asian equities for their better growth outlook. We also expect an improved outlook for emerging market equities, especially markets that are well supported by structural growth and recovery of oil prices.
In Asia, we are overweight in China, India and Indonesia, which are expected to outperform their regional peers due to their domestic demand-driven growth, positive progress of structural reforms and supportive policies. Their resilient domestic fundamentals should limit the potential damage from growing trade barriers pioneered by the new US administration.
In Europe, the Middle East and Africa, we favour Russia and the United Arab Emirates, both beneficiaries of higher oil prices.
SPIKE IN BOND YIELDS IS UNSUSTAINABLE
Financial markets have enthusiastically priced in the potential reflation of the US economy under the Trump presidency. But the danger is that the aggressive price action may get ahead of fundamentals.
In particular, we think the sell-off of US Treasuries looks overdone, with the 10-year Treasury yield surging beyond our first-quarter 2017 target of 2.5 per cent.
We believe the current yield level is unsustainable, as the all-time high US government debt levels could push the costs of debt servicing to unsustainable levels. The strengthening US dollar has already led to an overall tightening of financial conditions, thus limiting the need for any rapid Federal Reserve interest rate hikes.
More importantly, medium- to long-term structural drivers, including quantitative easing in Europe and Japan as well as elevated debt levels globally should constrain the Fed's scope to raise rates.
If US bond yields rise much further, this would be an obstacle to growth. Higher interest rates and a stronger US dollar will go against the goal of Mr Trump to make America great again.
FED RATE HIKES WILL REMAIN GRADUAL
In contrast with the Fed's forecasts, HSBC economists expect only two 25-basis-point rate hikes in the US this year, and one more in 2018.
Although bond yields could overshoot further in the short term, we stick to our view that US 10-year Treasury yield will likely edge down again after peaking at 2.5 per cent in the first quarter and fall towards 1.35 per cent by year-end.
We maintain our positive view on US investment-grade and high- yield bonds, and US dollar-denominated emerging market bonds. We believe any reversal of US yields would drive investors' search for yield and support the recovery of the credit markets.
We think the significant yield pick-up should allow US and Asian high-yield bonds to outperform sovereign and investment-grade bonds. US and Asian high-yield bonds are better insulated from rising US yields than investment-grade bonds due to their shorter duration and wider spread buffers to offset interest rate volatility.
ADD GOLD FOR RISK DIVERSIFICATION
To achieve portfolio risk diversification, we prefer to add gold, which offers an investment instrument to hedge against political risks, trade protectionism and inflation threat.
As we expect bond yields will eventually come down in 2017 and markets will become more nervous about political uncertainties in Europe, the gold price is likely to find support. In fact, gold demand from China and India has started to pick up at the current lower price levels.
The expansionist fiscal policies of the Trump administration and higher long-term inflation expectations are supportive of gold. We expect gold prices will recover after the first quarter of this year and move towards our year-end target of US$1,550 per ounce when investor fears of rapid US rate hikes ease.
•The writer is managing director and head of investment strategy, Asia, at HSBC Private Bank.
A version of this article appeared in the print edition of The Sunday Times on January 01, 2017, with the headline 'Going west and east for best opportunities in 2017'. Print Edition | Subscribe
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