The list of major global political surprises lengthened in late 2016, with the election of Donald Trump and the Republican sweep in the US following Britain’s earlier decision to leave the European Union. Both these events, along with the unsuccessful Italian referendum in December and a slew of European elections in 2017 may presage a possible ‘retreat from globalisation’. At the least, global political and trade policy uncertainty has intensified in late 2016 and early 2017.
In the meantime, however, and especially since the US elections, markets have edged further away from the ‘risk-on/risk-off’ environment characteristic of the past few years. The earlier decline in inflation expectations and bond yields appears also to have been arrested. These moves have been accompanied by subtle shifts in the policy stances of many central banks in Q4, including a second rate increase in the US and a prospective reduction in the monthly size of ECB asset purchases.
Indeed, investor risk appetite already had been improving before the US elections, amid signs of a broadening in global growth. Nevertheless, even with the US now at full employment, the new US administration is suggesting a substantial easing in US fiscal policy over the next two years, including significant corporate and personal taxation reform, tax incentives for new infrastructure spending and a substantial lift in defense spending.
Correspondingly, US long yields have continued to rise steadily, the US 5-year yield increasing to the highest level since 2011 (2.0%) and the 10-year yield to the highest level since mid-2014 (2.56%). Awaiting clarity around the new Administration’s fiscal strategy, however, at its December meeting the Fed increased the number of expected rate increases in 2017 (i.e. the median of the ‘dots’) from two to three, and left the subsequent pace of tightening broadly unchanged. Most of the increase in US yields has thus followed a sharp rise in inflation breakevens, and has been reflected in a sharp steepening in the US yield curve.
Closer to home, Australia’s GDP contracted by 0.5% in Q3, the first quarterly decline since early 2011 and only the fourth since the current expansion commenced in mid-1991. Growth subsequently slowed to just 1.8% over the year to September (the lowest since 2009), down from 3.1% over the year to June. Unseasonably wet weather in much of Australia contributed to the decline in Q3, delaying construction activity and certain consumer purchases. Total public final demand also fell in the quarter, which was ‘payback’ for a strong 4.8% increase the previous quarter. Both these drags should at least partly unwind in Q4, providing a bounceback in GDP growth.
In markets this translated to equity markets performing strongly in the fourth quarter in AUD terms with renewed focus on the degree of fiscal stimulus that may flow from the new US government administration. The S&P/ASX 300 Index returned 4.9% over the quarter. Whilst, the broad MSCI World ex Australia Index was up 5.2% in hedged terms and up 7.7% in unhedged terms over the quarter, as the Australian dollar depreciated against the USD. Within equities, there was a rotation out of bond proxy sectors and into cyclical sectors, with Global Property Trusts (hedged) returning -2.2%. Global bond markets weakened over the quarter as inflation and growth expectations grew causing yields to lift sharply in Q4 after bottoming in mid 2016. Global sovereign bonds weakened, with the Barclays Capital Global Aggregate Bond Index returning -2.2%. and the Bloomberg Ausbond Treasury Index returning -3.8% for the quarter.
We think that global growth will pick up modestly in 2017, led by the emerging markets. However, economic growth is unlikely to be strong, with productivity growth remaining soft by historical standards. Higher inflation, on the back of a recovery in commodity prices and stronger labor markets, should support moves by the Federal Reserve (Fed) to raise interest rates at least twice in 2017, while the European Central Bank may start to consider reducing the degree of their accommodation further as the year develops.
We expect bond yields and equity prices to rise modestly in 2017, although any signs that the Fed is behind the curve could undermine both materially. The fundamentals for emerging market equities are positive, although the risk of trade tension with the US is a real, if unquantifiable, risk. The prospect of a material fiscal stimulus plan that would support US growth from 2018 onward should support the US dollar, although in contrast to past governments the new Trump administration is likely to resist significant appreciation.
Our investment performance
Mercer Growth returned 3.15% (before fees and taxes) in the December quarter, which was 0.4% ahead of its benchmark return. For the year to 31 December 2016, Mercer Growth returned 8.5% (before fees and taxes) which was -0.1% relative to its benchmark return. However, over longer periods, Mercer Growth was ahead of its benchmark by +0.7% p.a. and 0.9%p.a for three years and five years respectively.
On an after fees and tax basis versus peers, Mercer Growth returned 6.71% versus 6.32% for the SuperRatings Master Trust Median for the year. Mercer Growth remains strongly ahead of the Median over longer periods, +0.6% over three years (6.9% versus 6.3%) and +0.6% over five years (9.7% versus 9.1%).
Asset allocation and manager selection
As communicated previously, we continue with our ongoing asset allocation program to increase exposure to unlisted assets, across direct property, unlisted infrastructure and private debt. We also increased our underweight versus benchmark to low volatility equities sectors on the view that these sectors were overvalued and would underperform as bond yields lift further. We increased our FX hedging after the AUD became closer to fair value in late December; however remain underweight in the AUD versus benchmark due to risk management and valuation views.
On the manager selection side, we migrated our exposure in Vinva Australian shares from a long only exposure to a long short exposure. We continue to regard Vinva as one of the strongest quantitative managers in the Australian shares sector and this change provided a more effective way to access Vinva's full array of investment insights. Colchester was added as a locally appointed mandate within the Emerging Market Debt fund. Within Global Absolute Return Bonds, Pioneer was downgraded and terminated in December following the departure of its Co-PM and Head of Portfolio Constriction, which came on top of news that Pioneer's parent UniCredit is in discussions with Amundi around a sale of the business. In January, T. Rowe Price was appointed as a replacement.
For more information on Mercer Super Trust fund performance in Q4 2016, download our report or contact us using the form below.